---

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# UNITED STATES 
SECURITIES AND
EXCHANGE COMMISSION

# Washington, D.C. 20549

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# FORM 20-F

(Mark
One)

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

# OR

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

| | For
the fiscal year ended December 31, 2006
| | -------------------------------------------

# OR

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

# OR

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

| | Date
of event requiring this shell company report . . . . . . . . . . . . . . . .
| | ---------------------------------------------------------------------------------

# Commission file
number: 0-29884

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# BVR SYSTEMS (1998) LTD.(Exact name of
Registrant as specified in its charter)

# Not Applicable 
(Translation of
Registrants Name into English)

# Israel 
(Jurisdiction of
incorporation or organization)

# 16 Hamelacha Street,
Park Afek, Rosh Haayin 48091, Israel 
(Address of principal
executive offices)

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

|                                              |                                          
|--------------------------------------------- | -----------------------------------------
|
|
|
|
|Title of each class                           | Name of each exchange on which registered
|Ordinary shares, par value NIS 1.00 per share | OTC Bulletin Board                       

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

Securities
for which there is a reporting obligation pursuant to Section 15(d) of the Act. None.

Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
the period covered by the Annual Report: As of December 31, 2006, the issuer had
116,863,757 ordinary shares outstanding.

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

Yes  o    No  x

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

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

Yes x      No  o

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

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

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

Item 17  x Item 18  o

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

Yes o No x



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# TABLE OF CONTENTS

|                              |                                                                              | Page
|----------------------------- | ---------------------------------------------------------------------------- | ----
|
|
|
|
|                              |                                                                              |     
|INTRODUCTION                  | ii                                                                          
|                             
|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                                                              | 2   
|Item 4.                       | Information on the Company                                                   | 14  
|Item 5.                       | Operating and Financial Review and Prospects                                 | 28  
|Item 6.                       | Directors, Senior Management and Employees                                   | 43  
|Item 7.                       | Major Shareholders and Related Party Transactions                            | 54  
|Item 8.                       | Financial Information                                                        | 58  
|Item 9.                       | Offer and Listing Details                                                    | 59  
|Item 10.                      | Additional Information                                                       | 60  
|Item 11.                      | Quantitative and Qualitative Disclosures about Market Risk                   | 80  
|Item 12.                      | Description of Securities Other than Equity Securities                       | 82  
|                             
|PART II                       |                                                                              | 82  
|Item 13.                      | Defaults, Dividend Arrearages and Delinquencies                              | 82  
|Item 14.                      | Material Modifications to the Rights of Security Holders and Use of Proceeds | 82  
|Item 15.                      | Controls and Procedures                                                      | 82  
|Item 16.                      | Reserved                                                                     | 83  
|Item 16A.                     | Audit Committee Financial Expert                                             | 83  
|Item 16B.                     | Code of Ethics                                                               | 84  
|Item 16C.                     | Principal Accountant Fees and Services                                       | 84  
|Item 16D.                     | Exemptions from the Listing Standards for Audit Committees                   | 85  
|Item 16E.                     | Purchases of Equity Securities by the Issuer and Affiliated Purchasers       | 85  
|                             
|PART III                      |                                                                              | 85  
|Item 17.                      | Financial Statements                                                         | 85  
|Item 18.                      | Financial statements                                                         | 85  
|Item 19.                      | Exhibits                                                                     | 86  
|                             
|SIGNATURE                     | 88                                                                          
|                             
|INDEX TO FINANCIAL STATEMENTS | F-1                                                                         



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# INTRODUCTION

B.V.R.
          Systems (1998) Ltd., (BVR) an Israeli company, was formed in January
          1998 to receive all of the assets and liabilities of the defense-related
          business of BVR Technologies Ltd. in accordance with the terms of a
          reorganization plan. The reorganization plan was consummated, and BVR commenced
          operations as an independent company in October 1998, effective as of
          January 1, 1998. BVR is controlled by Chun Holdings LP.

Except
for the historical information contained herein, the statements contained in this annual
report are forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to our business, financial condition and
results of operations. Statements that use the terms believe,
anticipate, expect, plan, intend,
estimate, anticipate, project and similar expressions
in the affirmative and the negative are intended to identify forward-looking statements.
These statements reflect our current views with respect to future events and are based on
current assumptions, expectations, estimates and projections about our business and the
markets in which we operate and are subject to risks and uncertainties. Actual events
(including our results) could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including the risks discussed
in Item 3. Key Information  D. Risk Factors and elsewhere in this annual
report. Except as required by applicable law, including the securities laws of the United
States, we do not undertake any obligation nor intend to update or revise any
forward-looking statements, whether as a result of new information, future events or
otherwise.

As
used in this annual report, the terms we, us, our,
the Company and BVR mean B.V.R. Systems (1998) Ltd., and our
consolidated subsidiary, unless otherwise indicated.

All
references herein to dollars or $ are to United States dollars,
and all references to Shekels or NIS are to New Israeli Shekels.

References
in this annual report to Chun refer to our controlling shareholder, Chun Holdings LP.

References in
this annual report to fiscal 2003 refer to our fiscal year ended December 31, 2003,
references to fiscal 2004 refer to our fiscal year ended December 31, 2004,
references to fiscal 2005 refer to our fiscal year ended December 31, 2005 and
references to fiscal 2006 refer to our fiscal year ended December 31, 2006.

References
in this annual report to the Companies Law refer to the Israel Companies Law, 5759-1999.

Ehud
is a trademark jointly owned by Israel Aircraft Industries and us; and
Atas is our wholly-owned trademark. All other trademarks and trade names
appearing in this annual report are owned by their respective holders.

ii

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---



# PART I

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

Not
applicable.

|ITEM 2. | Offer
Statistics and Expected Timetable
|------- | ---------------------------------------

Not
applicable.

1

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|ITEM 3. | Key
Information
|------- | ---------------

# A. Selected Consolidated
Financial Data

We
derived the following selected consolidated financial data presented below for each of the
years ended December 31, 2004, 2005 and 2006 from our Consolidated Financial
Statements and related notes included in this annual report. The selected consolidated
financial data for the years ended December 31, 2003 and 2002 have been derived from
consolidated financial statements not included in this annual report. Our Consolidated
Financial Statements have been prepared in accordance with generally accepted accounting
principles in Israel, or Israel GAAP. Israel GAAP, as applicable to our financial
statements, differs in certain significant respects from accounting principles generally
accepted in the United States, or U.S. GAAP. See Note 21 to the Consolidated Financial
Statements included in this annual report for a discussion of certain differences between
Israel GAAP and U.S. GAAP.

You
should read the selected consolidated financial data together with the section entitled
Item 5. Operating and Financial Review and Prospects and our Consolidated
Financial Statements included elsewhere in this annual report. Please see Note 2 of our
Consolidated Financial Statements for an explanation of the number of shares used in
computing per share data.

|                                                                                                          | Year Ended December 31,
|--------------------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|
|Statement of Operations Data:                                                                             |                        
|Revenues                                                                                                  |                        
|Cost of revenues:                                                                                         |                        
|                                                                                                          |                        
|Gross profit                                                                                              |                        
|Operating expenses:                                                                                       |                        
|Research and development                                                                                  |                        
|Selling and marketing                                                                                     |                        
|General and administrative                                                                                |                        
|                                                                                                          |                        
|Total operating expenses                                                                                  |                        
|                                                                                                          |                        
|Operating profit (loss)                                                                                   |                        
|Financing expenses, net                                                                                   |                        
|Other Income (expenses), net                                                                              |                        
|                                                                                                          |                        
|Profit (loss) before income taxes                                                                         |                        
|Income tax expense                                                                                        |                        
|                                                                                                          |                        
|Net profit  (loss)                                                                                        |                        
|                                                                                                          |                        
|Basic and diluted profit (loss) per share                                                                 |                        
|                                                                                                          |                        
|Weighted average number of ordinary shares used in
  computing basic and diluted profit (loss)  per share |                        
|                                                                                                          |                        

* Restated pursuant to our compliance
with Accounting Standard No. 24, Share-Based Payments as further described in
this annual report in Item 5.  Operating and Financial Review and Prospects
 Critical Accounting Policies.

(1) Reclassified

2

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|                                                                                                                                                       | Year Ended December 31,
|------------------------------------------------------------------------------------------------------------------------------------------------------ | -----------------------
|
|
|
|
|
|Reconciliation to U.S. GAAP:                                                                                                                           |                        
|Net profit (loss)                                                                                                                                      |                        
|                                                                                                                                                       |                        
|Reversal of restatement according to Standard No. 24                                                                                                   |                        
|                                                                                                                                                       |                        
|Allocation of share expense issued to service providers                                                                                                |                        
|under the fair value based method                                                                                                                      |                        
|Compensation expense for all stock-based awards using 
the modified prospective method                                                                 |                        
|                                                                                                                                                       |                        
|Profit (loss) under U.S. GAAP                                                                                                                          |                        
|                                                                                                                                                       |                        
|Basic and diluted net profit (loss) per share under U.S.
GAAP                                                                                          |                        
|                                                                                                                                                       |                        
|Weighted average number of ordinary shares outstanding                                                                                                 |                        
|(in thousands) used in basic  profit (loss) per share                                                                                                  |                        
|calculation according  to  U.S. GAAP                                                                                                                   |                        
|                                                                                                                                                       |                        
|Weighted average number of ordinary shares outstanding
  (in thousands) used in diluted profit (loss) per share
  calculation according  to  U.S. GAAP |                        
|                                                                                                                                                       |                        

| | *
Restated pursuant to our compliance with Accounting Standard No. 24, Share-Based
Payments as further described in this annual report in Item 5. Operating
and Financial Review and Prospects  Critical Accounting Policies.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | **
Restated to correct the reconciliation to the U.S. GAAP in 2004 and 2005 in respect to
service providers which should have been accounted as employees in fiscal years 2004 and
2005. The Company adopted APB No. 25 in the years 2004 and 2005 and therefore no
compensation costs should have been recorded in respect to awards granted to service
providers.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 | As of December 31,
|-------------------------------- | ------------------
|
|
|
|
|
|Consolidated Balance Sheet Data: |                   
|Israeli GAAP:                    |                   
|Cash and cash equivalents        |                   
|Working capital (deficit)        |                   
|Total assets                     |                   
|Short-term bank credit and loans |                   
|Share capital                    |                   
|Shareholders equity (deficit)    |                   
|U.S. GAAP:                       |                   
|                                 |                   
|Total assets                     |                   
|                                 |                   
|Shareholders equity (deficit)    |                   

3

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# B. Capitalization and
Indebtedness

Not
applicable.

# C. Reasons for the Offer
and Use of Proceeds

Not
applicable.

# D. Risk Factors

Our
business, operating results and financial condition could be seriously harmed due to any
of the following risks. If we do not successfully address any of the risks described
below, we could experience a material adverse effect on our business, results of
operations and financial condition and our share price may decline. We cannot assure you
that we will successfully address any of these risks.

# Risks Related to our
Business

We have reported
operating and net losses in the past and may report operating and net losses in the
future.

We
commenced operations in 1998. We reported a net loss of $2.2 million for the year ended
December 31, 2006, a net profit of $114,000 for the year ended December 31, 2005, a net
loss of $1.2 million for the year ended December 31, 2004 and a net loss of $6.5
million for the year ended December 31, 2003. We can offer no assurance that we will
achieve profitable operations or that any profitable operations will be sustained. Future
profitability will depend on our ability to develop new products, the degree of market
acceptance of our existing and new products and the level of competition in the markets in
which we operate.

Although we had positive
shareholders equity and positive working capital since December 31, 2004, we may
still need to raise additional funds which may not be available.

As
of December 31, 2006, our shareholders equity was $5.4 million, and we had positive
working capital amounting to $ 3.5 million. We expect that our existing cash balance,
together with our forecasted cash flows from operating activities for fiscal 2007,
including orders forecasted in the budget approved by our Board of Directors, will be
sufficient for meeting our present working capital and capital expenditure needs. If our
operations do not generate cash to the extent currently anticipated or if any of the risk
factors discussed in this annual report materialize, we may need to raise additional funds
in the future for a number of uses, including:

| |  | implementing
further marketing and sales activities;
| | - | ----------------------------------------------------

| |  | hiring
additional qualified personnel; and
| | - | ------------------------------------------

| |  | expanding
research and development programs.
| | - | --------------------------------------------

4

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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 not be able to:

| |  | maintain
the level of our current operations;
| | - | ---------------------------------------------

| |  | develop
new products;
| | - | ---------------------

| |  | enhance
our existing products;
| | - | ------------------------------

| |  | remain
current with evolving defense technologies;
| | - | --------------------------------------------------

| |  | take
advantage of future opportunities; or
| | - | ------------------------------------------

| |  | respond
to competitive pressures or unanticipated requirements.
| | - | ---------------------------------------------------------------

Because we receive large
product orders from a relatively small number of customers, our sales and operating
results are subject to substantial periodic variations. Our revenues and operating results
for a specific quarter may not be indicative of our future performance, making it
difficult for investors to evaluate our future prospects based on the results of any one
quarter.

Due
to the nature of our customers and products, we receive relatively large orders for our
products from a relatively small number of customers. Consequently, individual orders from
individual customers can represent a substantial portion of our sales in any one period
and significant orders by any customer during one period may not be followed by further
orders from the same customer in subsequent periods. Our sales and operating results are
subject to very substantial periodic variations. Because our quarterly performance is
likely to vary significantly, the results of our operations for any quarter are not
necessarily indicative of the results that we might achieve for any subsequent period and
consequently, quarter-to-quarter comparisons of our operating results may not be
meaningful.

We may not be able to
convert our entire backlog into revenue.

We
sell the majority of our products through individual purchase orders. Many of our
customers have the right to terminate orders by paying the cost of work in process plus a
related profit factor. Customers may cancel orders due to the cancellation of a budget or
for other reasons. As of December 31, 2006, purchase orders and contractual arrangements
reached to approximately $22 million, compared with $12.7 million as of December 31, 2005.
If we experience cancellations of pending contracts, terminations or reductions of
contracts in progress, we may not be able to convert our entire backlog into revenue. Any
reduction in backlog will adversely affect our business, financial condition, results of
operations and cash flows.

5

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The loss of any of our
major customers would result in a loss of a significant amount of our revenues.

Four
of our customers, namely two customers located in Europe, one customer located in Israel
and the government of an Asian Pacific country that awarded us several projects, accounted
for 63% of our revenues in fiscal 2006. We cannot be certain that these and other
customers will maintain the size of their respective purchase orders, or will not
reschedule or cancel existing purchase orders. We expect that sales of our products to
relatively few customers will account for a significant portion of our net revenues for
the foreseeable future. Consequently, the cancellation of an order from any one customer
may have a material adverse effect on our business, financial condition, results of
operations and cash flows.

Because competition in
the market for our products is intense, we may lose market share, and we may be unable to
achieve or maintain profitability.

We
compete with numerous other contractors on the basis of product performance, price,
reputation, technical and managerial capability, product maintenance cost and
responsiveness to customers requirements. Our ability to successfully compete for
and retain such new projects and customers is highly dependent on technical excellence,
management proficiency, strategic alliances, cost-effective performance and the ability to
recruit and retain key personnel.

The
continuing consolidation of the global defense industry, which has decreased the number,
but increased the relative size and resources of our competitors, has resulted in
intensified competition. Some of the competitors which are the top-tier contractors for
competing products have substantially greater financial, marketing and other resources
than ours. These contractors compete with us in some cases by offering more aggressive
pricing and devoting greater resources to product marketing or development than we do.
This competition may result in lower prices or reduced demand for our products and a
corresponding reduction in our revenues that may impair our ability to achieve and
maintain profitability.

We rely on contracts with
governments and defense contractors entities that entail certain risks, all of
which may adversely affect our operations.

As
is the case with many companies that derive a substantial portion of their revenues from
government contracts for defense-related products, our business is subject to specific
risks, which include changes in governmental appropriations and national defense policies
and priorities, a change of government in the customers country, as well as
political changes or alterations in the governments policy regarding the issue of
export and import permits to various countries and the policies of specific governments to
favor local over foreign defense products suppliers. We may be negatively affected by one
or more of these factors.

6

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Generally,
our contracts with governments may be terminated or suspended by such governments as a
result of factors which may not depend on us, including as a result of a decrease in the
defense budget, a decline in the military expenditures of governments, the cancellation or
a significant cutback of a large project in which we participate or as a result of
situations such as a state of war, force majeure or other circumstances seriously
disrupting the public safety, peace or good order of the customers country. Our
contracts with non-governmental military contractors sometimes contain similar provisions.
In cases in which we received advanced payments prior to incurring the cost of fulfilling
such contracts, we realized a positive project cash flow. Particularly, in the last
threeyears, we have received substantial advances under our contracts. In the
event of an early termination of a contract, we may be required to return a portion of
such advanced payment. Upon such early termination, we would, in most cases, be entitled
to reimbursement for our incurred contract costs and to payment of a proportionate share
of our fee or profit for the work actually performed. In order to reduce risks of
financial exposure resulting from an early termination of a contract, we attempt to
stagger funding for projects in accordance with the rate of performance and to ensure
ourselves from that risk by providing for positive cash flow in the life cycle of the
program. If, however, we are not entitled to all or a portion of such compensation our
operations and cash flows would be adversely affected.

Our ability to export our
products is subject to approvals by Israeli and United States governmental agencies.

Our
export of military goods and information is subject to approval of SIBAT, the Foreign
Defense Assistance and Defense Export Organization of the Israel Ministry of Defense. To
date, we have received all required approvals from SIBAT, but there can be no assurance
that we will receive such approvals in the future or that the Israeli government will not
impose additional requirements on our manufacturing or export activities, which may
require us to incur additional substantial expenses or which may otherwise have a material
adverse effect on our operations. SIBATs policy has generally been to encourage the
export of military goods and knowledge; however, SIBAT generally does not permit sales to
countries that are in a state of war or hostility with Israel and countries which may
otherwise endanger the State of Israel.

We
purchase from manufacturers in the United States a portion of the commercial computers, a
portion of the air combat maneuvering instrumentation pods hardware and other
off-the-shelf products, such as navigation systems, which we incorporate into
our products. The export of such components is subject to the approval of the United
States Department of Commerce and/or the United States Department of Defense, which often
restricts sales to certain countries. Following the events of September 11, 2001, we
experienced delays in the receipt of such required approvals. For example, we experienced
a delay in the delivery of several components of a system to a customer and incurred
additional costs, as a result of the need to modify such components, because of a delay in
the receipt of an export approval that has since been obtained. Further, there can be no
assurance that we will receive such approvals in the future or that the United States
Government will not impose additional requirements on our manufacturing or export
activity, which might require us to incur substantial expenses, and/or find and contract
with alternative suppliers in countries that do not impose similar export restrictions.

7

---

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International political
and economic uncertainty could have an adverse impact on our business and on our operating results.

In
fiscal 2006, 77% of our total revenues came from foreign customers. We estimate that a
material portion of our revenues in 2007 will come from foreign customers. The
international political and economic uncertainty and the ongoing war on terrorism may
adversely impact our ability to maintain the level of our sales to our existing customers
located abroad and to develop new business in these and other foreign countries.

We are exposed to
general, global economic and market conditions.

Our
business is subject to the effects of general economic conditions globally, and, in
particular, conditions in the market for simulation systems for military and civilian
applications. Our sales efforts can be adversely affected as a result of unfavorable
economic conditions. We may experience material adverse impacts on our business, operating
results, and financial condition.

Our contracts have a
fixed-price and payment thereunder is subject to timely accomplishment of milestones,
which may subject us to unfavorable terms.

The
majority of our contracts are for a fixed-price, meaning they are not subject to
adjustment for the costs incurred in the performance of the contract. Consequently, we
assume the risk that increased or unexpected costs may reduce our profits or generate a
loss. The risk can be particularly significant under a fixed-price contract involving
research and development with respect to new technologies.

The
majority of our contracts with our customers provide that after we receive an advance
payment at the commencement of a project, additional payments are payable upon progress or
achievement of specific milestones. In a majority of the projects, in addition to the bank
guarantees that are generally provided by us for the advance payments, we are required to
provide performance guarantees in an amount equal to a specific percentage of the contract
price.

Most
agreements with our customers impose penalties or reduce the amount payable to us in the
event that the completion of a phase of a project is delayed. In addition, we are
generally responsible for the delays and defaults of our subcontractors. To mitigate our
risk, we attempt to impose liability on our subcontractors on a back-to-back
basis when such subcontractor is in delay or default which, in turn, could expose us to
liability pursuant to the main contract. However, we may not be able to obtain full
recovery for such liabilities from such subcontractors.

8

---

---



We
may encounter significant reduction in profits or incur losses as a result of one or more
of the above unfavorable terms.

We are controlled by Chun
Holdings LP which, in the aggregate, beneficially owns approximately 54.03% of our
outstanding Ordinary Shares. Therefore, Chun is able to elect the majority of our
directors and exercise control over the outcome of matters requiring shareholders
approval.

As
of March 31, 2007, Chun Holdings L.P., an Israeli limited partnership beneficially owned
an aggregate of 58,142,608 of our ordinary shares and an immediately exercisable warrant
to purchase an additional 10,864,444 of our ordinary shares (representing, assuming the
exercise of such warrant and assuming no other exercise of our warrants and options,
approximately 54.03% of our currently outstanding ordinary shares). As a result, Chun
controls the outcome of various actions that require our shareholder approval. For
example, Chun could elect most of our directors, delay or prevent a transaction in which
shareholders might receive a premium over the prevailing market price for their shares and
prevent changes in control or management.

Because we operate in
international markets, we are subject to additional risks.

We
currently offer our products in a number of countries and a key component of our marketing
strategy is to continue to expand in foreign markets. Our business is subject to risks
which often characterize international markets, including:

| |  | economic
and political instability;
| | - | -----------------------------------

| |  | import
or export licensing requirements;
| | - | ----------------------------------------

| |  | difficulties
in collecting accounts receivable;
| | - | -----------------------------------------------

| |  | longer
payment cycles;
| | - | ----------------------

| |  | unexpected
changes in regulatory requirements and tariffs;
| | - | ----------------------------------------------------------

| |  | fluctuations
in exchange rates;
| | - | -------------------------------

| |  | potentially
adverse tax consequences; and
| | - | -----------------------------------------

| |  | potentially
weak protection of intellectual property rights.
| | - | ------------------------------------------------------------

These
risks may impair our ability to generate revenues from our overseas sales efforts, which
constitute the majority of our business.

9

---

---



Our profitability could
suffer if third parties infringe upon our proprietary technology.

Our
profitability could suffer if third parties infringe upon our intellectual property rights
or misappropriate our technologies and trademarks for their own businesses. To protect our
rights to our intellectual property, we rely on a combination of patent, trademark and
copyright laws, trade secret protection, confidentiality agreements and other contractual
arrangements with our employees, some of our affiliates, strategic partners and others. We
currently own five patents registered in the United States and three additional patents
registered in several other countries, along with several registered and pending
trademarks, filed in several countries. Several of these patents were also granted or
applied for in Israel and/or in several countries in Europe and worldwide. The protective
steps we have taken may be inadequate to deter misappropriation of our proprietary
information. We may be unable to detect the unauthorized use of, or take appropriate steps
to enforce, our intellectual property rights. Effective patent, trademark, copyright and
trade secret protection may not be available in every country, especially in Asia Pacific,
in which we offer, or intend to offer, our products. Any failure to adequately protect our
intellectual property could devalue our proprietary content and impair our ability to
compete effectively. Further, defending our intellectual property rights could result in
the expenditure of significant financial and managerial resources.

Our products may infringe
on the intellectual property rights of others.

Third
parties may assert against us infringement claims or claims that we have violated a patent
or infringed a copyright, trademark or other proprietary right belonging to them. Any
infringement claim, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.

# Risks Relating to Our
Location in Israel

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

We
are incorporated under Israeli law and our principal offices, research and development and
manufacturing facilities are located in the State of Israel. Political, economic and
military conditions in Israel directly affect our operations. Since the establishment of
the State of Israel in 1948, a number of armed conflicts have taken place between Israel
and its Arab neighbors, and the continued state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel. During the summer of
2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite
militia group and political party. This conflict involved missile strikes against civilian
targets in northern Israel, and negatively affected business conditions in Israel. In
addition, Israel and companies doing business with Israel have, in the past, been the
subject of an economic boycott. Although Israel has entered into various agreements with
Egypt, Jordan and the Palestinian Authority, Israel has been and is subject to civil
unrest and terrorist activity, with varying levels of severity, since September 2000. The
election in early 2006 of representatives of the Hamas movement to a majority of seats in
the Palestinian Legislative Council and the tension among the different Palestinian
factions may create additional unrest and uncertainty. Any future armed conflicts or
political instability in the region may negatively affect business conditions and
adversely affect our results of operations. Parties with whom we do business have
sometimes declined to travel to Israel during periods of heightened unrest or tension,
forcing us to make alternative arrangements when necessary. In addition, the political and
security situation in Israel may result in parties with whom we have agreements involving
performance in Israel claiming that they are not obligated to perform their commitments
under those agreements pursuant to force majeure provisions in the agreements. To date, we
do not believe that the political and security situation has had a material adverse impact
on our business but we cannot give any assurance that this will continue to be the case.
However, if there were to be emergency conditions, some of our key employees may be called
to active duty for extended periods of time and could adversely affect our operations. Any
hostilities involving Israel or the interruption or curtailment of trade between Israel
and its present trading partners could also adversely affect our operations and could make
it more difficult for us to raise capital.

10

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Our
insurance does not cover losses that may occur as a result of events associated with the
security situation in the Middle East. Although the Israeli government currently covers
the reinstatement value of direct damages that are caused by terrorist attacks or acts of
war, we cannot assure you that this government coverage will be maintained. Any losses or
damages incurred by us could have a material adverse effect on our business. Any armed
conflicts or political instability in the region would likely negatively affect business
conditions and could harm our results of operations.

Like
all male adult citizens and permanent residents of Israel, our directors, officers and
employees who are under the age of 45, unless exempt, are obligated to perform up to 36
days of military reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty. No
assessment can be made as to the full impact of such requirements on our workforce or
business if conditions in Israel should change, and no prediction can be made as to the
effect of any expansion or reduction of such military obligations on us. See Item 4.  Information on the Company  B.
Business Overview Conditions in Israel.

Our operations may be
affected by negative economic conditions in Israel.

In
recent years, Israel has experienced periods of recession in economic activity, resulting
in low growth rates and growing unemployment. Our operations could be adversely affected
if the economic conditions in Israel deteriorate. In addition, due to significant economic
measures proposed by the Israeli government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports, and threats of
general strikes and work stoppages within key economic sectors of the Israeli economy have
arisen during the first four months of 2007. These strikes have had an adverse effect on
the Israeli economy and on business, including our ability to deliver products to our
customers or to receive raw materials from our suppliers in a timely manner. From time to
time, the Israeli trade unions threaten strikes or work-stoppages, which may, if carried
out, have a material adverse effect on the Israeli economy and our business.

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If we are considered to
be a passive foreign investment company, either presently or in the future, U.S. Holders
will be subject to adverse U.S. tax consequences.

We
will be a passive foreign investment company, or PFIC, if 75% or more of our gross income
in a taxable year, including our pro rata share of the gross income of any company, U.S.
or foreign, in which we are considered to own, directly or indirectly, 25% or more of the
shares by value, is passive income. Alternatively, we will be considered to be a PFIC if
at least 50% of our assets in a taxable year, averaged over the year and ordinarily
determined based on fair market value, including our pro rata share of the assets of any
company in which we are considered to own, directly or indirectly, 25% or more of the
shares by value, are held for the production of, or produce, passive income. If we were to
be a PFIC, and a U.S. Holder does not make an election to treat us as a qualified
electing fund, or QEF, or a mark to market election, excess
distributions to a U.S. Holder, and any gain recognized by a U.S. Holder on a
disposition or our ordinary shares, would be taxed in an unfavorable way. Among other
consequences, our dividends would be taxed at the regular rates applicable to ordinary
income, rather than the 15% maximum rate applicable to certain dividends received by an
individual from a qualified foreign corporation. The tests for determining PFIC status are
applied annually and it is difficult to make accurate predictions of future income and
assets, which are relevant to the determination of PFIC status. In addition, under the
applicable statutory and regulatory provisions, it is unclear whether we would be
permitted to use a gross loss from sales (sales less cost of goods sold) to offset our
passive income in the calculation of gross income. In light of the uncertainties described
above, we have not obtained an opinion of counsel with respect to our PFIC status and no
assurance can be given that we will not be a PFIC in any year. If we determine that we
have become a PFIC, we will then notify our U.S. Holders and provide them with the
information necessary to comply with the QEF rules. If the IRS determines that we are a
PFIC for a year with respect to which we have determined that we were not a PFIC, however,
it might be too late for a U.S. Holder to make a timely QEF election, unless the U.S.
Holder qualifies under the applicable Treasury regulations to make a retroactive (late)
election. U.S. Holders who hold ordinary shares during a period when we are a PFIC will be
subject to the foregoing rules, even if we cease to be a PFIC in subsequent years, subject
to exceptions for U.S. Holders who made a timely QEF or mark-to-market election.

We benefit from
government programs and tax benefits that may be discontinued or reduced.

We
have received grants and are entitled to tax benefits under Government of Israel programs.
In order to maintain our eligibility for these programs and benefits, we must continue to
meet specified conditions, including making specified investments in fixed assets and
paying royalties with respect to grants received. In addition, some of these programs
restrict our ability to manufacture particular products or transfer particular technology
outside of Israel. If we fail to comply with these conditions in the future, the benefits
received could be cancelled and we could be required to pay increased taxes. The
Government of Israel has reduced the benefits available under these programs in recent
years, and these programs and tax benefits may be discontinued or curtailed in the future.
If the Government of Israel ends these programs and tax benefits, our business, financial
condition and results of operations could be affected.

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Because a substantial
portion of our revenues is generated in U.S. Dollars and a portion of our expenses is
incurred in New Israeli Shekels, our results of operations may be seriously harmed if
the rate of inflation in Israel exceeds the rate of devaluation of the New Israeli
Shekel against the U.S. Dollar.

We
generate a substantial portion of our revenues in dollars, but we incur a portion of our
expenses, principally salaries and related personnel expenses, in New Israeli Shekels, or
NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will
exceed the rate of devaluation of the NIS in relation to the dollar or that the timing of
this devaluation lags behind inflation in Israel. In 2006, the rate of inflation together
with the appreciation of the dollar in relation to the NIS, reduced our dollar-linked
results of operations. In case the rate of inflation in Israel will exceed the rate of
devaluation of the NIS in relation to the dollar or that the timing of this devaluation
lags behind inflation in Israel, our dollar-linked results of operations will be adversely
affected.

Provisions of Israeli law
may delay, prevent or make difficult and acquisition of us, which could prevent a change
of control and therefore decrease 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. See Management  Approval of Related Party
Transactions under Israeli Law for additional information about some anti-takeover
effects of Israeli law.

It may be difficult to
enforce a U.S. judgment against us, our officers and directors named in this annual
report or to assert United States securities laws claims in Israel or serve
process on our officers.

We
are incorporated in the State of Israel. All of our executive officers and directors named
in this annual report are not residents of the United States, and a substantial portion of
our assets and the assets of these persons are located outside the United States.
Therefore, it may be difficult to enforce a judgment obtained in the United States based
upon the civil liabilities provisions of the United States Federal securities laws against
us or any of those persons or to effect service of process upon these persons in the
United States. Additionally, it may be difficult to enforce civil liabilities under United
States federal securities laws in original actions instituted in Israel.

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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 the holders of our
Ordinary Shares are governed by 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. See Item 10. Additional
Information  B. Memorandum and Articles of Association.

|ITEM 4. | Information
on the Company
|------- | --------------------------

# A. History and
Development of the Company

B.V.R.
          Systems (1998) Ltd., an Israeli company, was formed in January 1998 to receive
          all of the assets and liabilities of the defense-related business of BVR
          Technologies Ltd., or BVR-T, in accordance with the terms of a reorganization
          plan. The reorganization plan was consummated, and BVR commenced operations as
          an independent company in October 1998, effective as of January 1,
          1998. Our principal executive offices and research and development facilities
          are located at 16 Hamelacha Street, Afek Industrial Park, Rosh Haayin
          48091, Israel, and our telephone number is 972-3-900-8000. Our manufacturing
          facilities are located in Ashdod, Israel. Our wholly-owned subsidiary, BVR-S
          Pacific PTE, which is incorporated under the laws of Singapore, is located in
          Singapore.

In
February 2006, we entered into a non-binding term sheet for the acquisition of all of the
shares of the U.S.-based corporation Blue Ridge Simulation, Inc. (BRS). BRS is a
privately-held supplier of high-performance radar simulators for the U.S. Department of
Defense, commercial and international training applications. In consideration, BVR will
pay up to five million dollars in the combined form of BVRs shares and cash
payments. The closing of this transaction is subject to our due diligence review of BRS,
the execution of definitive transaction documents and the receipt of customary third-party
and regulatory approvals. The Company has decided to halt the application process and the
approval of the Committee on Foreign Investment in the United States which is required for
the acquisition and the completion of the transaction.

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In
March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership
led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the
issuance of 20,000,000 ordinary shares, representing approximately 17% of our issued share
capital, at a price per share of $0.18. In connection with this investment, HSN was issued
three separate warrants for the purchase of 6,000,000 of our ordinary shares per each
warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three
years, with a mandatory exercise mechanism under certain conditions. As of the date of
this annual report, none of these warrants have been exercised. Pursuant to this
investment, Mr. Dor was appointed to serve as a member of our board of directors and shall
be entitled to continue to serve on the board, either personally or to nominate a
representative on his behalf for such time that the Israeli limited partnership holds at
least nine percent of our outstanding share capital.

Our
web site is www.bvrsystems.com. Information on our web site is not incorporated by
reference in this annual report.

# Capital Expenditures

Since
January 1, 2004, our capital expenditures amounted to approximately $0.9 million. The
focus of our capital expenditure program primarily included investment in computers and
electronic equipment.

# B. Business Overview

BVR is engaged in the military
training and simulation industry. According tothe international business
consulting firm of Frost & Sullivan, the overall market size of our industry is
estimated to be approximately $8 billion per year. The overall market can be divided into
the following main segments: live and embedded training; virtual training (simulators);
and constructive training. Each of these training methods can be further sub-divided into
applications for air, ground and navalsystems.

# General

We
are engaged in the development, manufacture, marketing and sale of sophisticated training
and simulation systems for military applications. We are currently engaged in the
following areas:

| |  | Live
and Embedded training systems:
| | - | -----------------------------------

| |  | On-Board,
Combat Training Systems such as the "Ehud(TM)"; Air Combat Maneuvering Instrumentation,
or ACMI, Naval                            Combat Instrumentation System, or NCMI; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Embedded
simulation systems such as Embedded Virtual Avionics or EVA, and In-Flight Electronic
Warfare Simulation, or IFEWS.
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | Virtual
and Constructive Training systems, such as:
| | - | ---------------------------------------------------

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| |  | Flight
simulators for fighter aircraft, helicopters, trainer aircraft, unmanned aerial vehicles;
| | - | ------------------------------------------------------------------------------------------------

| |  | Armored
& Gunnery Simulators and Infantry Simulators; and
| | - | ---------------------------------------------------------

| |  | Naval
Tactical Trainers, or NTT, and Action Speed Tactical Trainers, or ASTT
| | - | ----------------------------------------------------------------------------

Our
products offer advanced, highly effective and cost-efficient solutions to operational and
tactical training needs. Our products are based on a complete training philosophy, which
enables our customers to reduce the amount of actual military equipment used in training
while enhancing the quality of the training exercises, thereby significantly reducing the
risks associated with actual operations and training in a live operational scenario. In
addition, our diversified product offerings are aimed to improve the mission preparedness
of armed forces by simulating their combat environment with realistic tactical scenarios,
thereby allowing networked training between multiple forces to optimize the joint-force
operations essential for modern battlespace.

# Our Product Offerings

We
continuously design, develop and market new generation technologies for live, embedded,
virtual and constructive training. The advances we made in the field reflect our vast
experience, unique approach to technological innovation and our drive to singularly
fulfill the needs of our global military customers.

# Live and Embedded
Training

Our
live and embedded training systems are designed to improve real-time management,
monitoring, training, safety and debriefing for live training exercises and operations
carried out by modern air, naval and ground forces. The on-board training product line
includes the following systems:

Ehud ACMI

Air Combat Maneuvering
Instrumentation

The
Ehud air combat maneuvering instrumentation, or ACMI, system is a complete on-board,
autonomous training and safety suite. This system is designed to enhance the airborne
training of an aircraft crew on a wide variety of missions.

Ehud
offers a unique combination of range-less, real-time and post-flight training and
debriefing systems together with safety warnings and operational capabilities. The system
is effective for air-to-air, air-to-ground and electronics warfare pilot training with an
unlimited number of participants due to our patented datalink protocol which dynamically
auto-adapts the data exchange rate according to the actual number of participants in the
network.

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The
EhudACMI system includes features such as mid-air and ground collision warning
systems, which significantly enhance training safety. The Ehud ACMI system has been
flying operationally since 1994 and has been delivered to many leading air forces around
the world.

Naval Combat
Instrumentation System

Our
naval combat maneuvering instrumentation, or NCMI, is a full-scale on-board training
system. The system enables the conduct of both live field training sessions at sea
and constructive war-gaming exercises ashore.

The
basic concept behind our NCMI is the deployment of a distributed embedded simulation
system on-board an instrumented ship and a maritime patrol aircraft.

Our
NCMI system supports the debriefing, analysis, and evaluation of naval warfare exercises
at all command levels.

Our
NCMI system supports various training levels ranging from operators training at
console level, through sub-team and team training, and up to full fleet training. Our NCMI
system provides training in tactical simulators and enhances the reality of seaborne
exercises through the use of computer generated forces integrated with live exercises.
Typically, the exercise is coordinated between the participants via a datalink system,
which supports the creation of a distributed simulation network.

# Embedded Simulation

We
are currently marketing a wide range of embedded simulation solutions. These advanced
solutions are an outcome of the synergies gained from the combination of on-board training
and simulation technologies. With vast experience in these two fields, we believe that we
are well positioned to play a leading role in this evolving market.

Embedded Virtual Avionics
Suite, or EVA

Our
Embedded Virtual Avionics Suite, or EVA, is a state-of-the-art embedded simulation suite,
installed on basic or advanced trainer aircraft, transforms training aircraft into virtual
advanced fighter aircraft. A training aircraft equipped with EVA may offer capabilities
such as virtual sensors and weapons, in-flight live or virtual target threats, operational
scenarios of gradually increasing complexity, full debriefing capabilities and flight
safety features. Our proprietary EVA technology is based on a patent owned by us and
registered in numerous countries, including the United States and several European
countries.

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An
EVA standard training aircraft is equipped or refitted to replicate the cockpit and
avionics instrumentation panel of specifically targeted advanced fighters. The refitted
trainers will resemble the behavior, displays and controls of the advanced fighter sensors
(such as air-to air radar, air to ground radar and radar warnings receiver, which is part
of the electronic warfare suite of most advanced fighters and seekers) and weapon systems.
Pilots flying the EVA-fitted trainer benefit from a real-time feel and capabilities of the
simulated advanced fighter aircraft. The system offers features such as collision
avoidance and hazard warning.

In 2006, we received two orders for
the integration of EVA within the avionics suite of two trainer aircrafts.

In addition, in December 2006 we
signed a license agreement with a European aircraft manufacturer that entitles BVR to
receive royalties for each aircraft which includes embedded simulation sold by this
licensee.

In-Flight Electronic
Warfare Simulation, or IFEWS

Our
in-flight electronic warfare simulator, or IFEWS, is a complete, autonomous,
on-board threat-environment training and safety suite. The system is an embedded simulator
for the training and debriefing of electronic warfare, or EW, scenarios, simulating the
real EW systems in an aircraft. IFEWS provides a virtual EW range and includes our
post-flight debriefing capabilities.

Our
IFEWS generates a wide range of on-board simulation of virtual ground and airborne
threats. The virtual range, created and managed by the IFEWS computer, authentically
simulates the characteristics, behavior and interactions of both the threatening weapon
systems and the aircrafts self protection suite. Our system is tightly coupled to
the aircrafts existing EW suite. IFEWS simulates all relevant modes of weapon
system, including optical tracking modes and other modes not received by the airborne EW
suite.

After
landing, our PC-based ground station provides advanced After-Action Review and debriefing
with a 3D analysis of crew performance, all weapon engagements, safety events and mission
scenarios.

Based
on the legacy of the Ehud ACMI systems, IFEWS provides multiple
features including real-time training, realistic virtual threats, safety elements and
debriefing capabilities.

In
the first quarter of 2002, we completed preliminary flight tests with the Israel Air
Force, and we conducted further demonstration flight tests with the Israel Air Force
during the remainder of 2002.

In
2005, we received a follow on order from the Israel Air Force for the installation of
IFEWS systems on its CH-53 and C-130 Fleets.

In
2006, we received an order from a European NATO country for the installation of IFEWS on
part of its helicopters fleets.

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For
additional information with respect to these purchase orders, see Item 10.
Additional Information  C. Material Contracts.

# Virtual and Constructive
Training

We
provide flight, naval and ground forces simulators for various platforms, electronics and
weapon systems. Our line of simulators covers a full range of training scale, from basic
procedural training to combat mission training and full mission training. Our simulators
support the high level architecture world-wide standard for simulators connectivity
delivering the capacity to perform sophisticated distributed mission training by
communicating and training with other simulators and training devices. Our product
offerings include:

| |  | Flight
Simulators;
| | - | ------------------

| |  | Ground
Forces Simulators;
| | - | -------------------------

| |  | Naval
Simulators; and
| | - | ---------------------

| |  | Weapon
and Electronic Systems Simulators
| | - | ----------------------------------------

Flight Simulators

Fighter
Aircraft Simulators.We have developed and manufactured fighter aircraft simulators
for numerous aircrafts, including the F-16C, F-16D, F-15, F-5, A-4 and Mirage-2000.

Full
Mission Simulators.Our full mission simulators provide training for all aspects of a
missions flight and procedures, including sophisticated weapon system simulations,
sensors and full standard and emergency procedure training. These simulators encompass a
high-fidelity cockpit replica and a large variety of visual systems covering a field of
view of up to 360°.

We
use high-end computers and personal computers, or PCs, as image generators to provide the
trainee with a high-resolution, fully-textured outside world visual presentation, based on
satellite imagery and three dimensional targets and shapes.

Our
full mission simulators provide pilots with complex tactical training, using multiple
computer generated forces, such as air, land, or sea participants.

Trainer
Aircraft Simulators.We developed and manufactured trainer aircraft simulators for
numerous aircraft, including the PC-7, MB-339 MLU, MB339 C/D and Fouga Magister.

AMOS
 Cadet Screening Simulator.Our AMOS cadet screening and basic flight training
simulator has been developed for the Israel Air Force Fouga Magister trainer.

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Our
system provides a methodology for the analysis of cadets learning abilities, through
screening while training.

Helicopter
Full Mission Simulator.

We
developed and manufactured helicopter simulators for helicopters, including the AS-550.

Our
full mission simulators for helicopters are offered for assault and fully armed attack
helicopter simulation. The simulators are offered in a number of configurations, from a
limited front view outside world imagery to a full dome display. The full dome display
configuration includes a full-size cockpit replica for two pilots with a three channel
high-resolution full color outside world display. The resulting imagery fidelity level
enables the system to perform low flying missions and weapon deployment simulation. The
system is capable of simulating typical helicopter flights and attacks, including a full
range of malfunctions and emergency procedures. Our simulators also provide for tactical
training as the trainee can fly against user pre-programmed computer generated forces.

Unmanned Air Vehicle
Mission Simulators

We
developed and manufactured an unmanned air vehicle, or UAV, and tactical mission
simulators for tactical UAV, for both the external pilot and the internal mission crew.

Our
UAV mission simulator supports training on near-to-real-life quality imaging systems for
the entire crew. Training can be executed both individually and as a team.

Armor and Gunnery
Simulation Systems for Ground Forces

Integrated
Tactics and Armor Combat Trainer. Our integrated tactics armor and weapon system
vehicle combat trainer, or INTACT system, fulfills the need for effective training,
debriefing and evaluation of army units. Our INTACT system was developed by experienced
army officers. INTACT is a multi-station armor and weapon vehicle tactical simulator
system. Our INTACT system provides training that ranges from individual level to combat
team multi-participant tactical exercises.

Our
INTACT system provides training levels from individual precision gunnery to combat team
multi-participant exercises and beyond. The training can include unlimited combinations of
manned and computer generated forces. The INTACT system fills the need for effective
training, debriefing and evaluation of ground forces. Our INTACT system simulates virtual
forces and integrates their actions with real forces, adding value to performance and
cost-effective training.

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Naval Simulators

We
developed a diversified product line of naval simulators based on dedicated replica
workstations and sophisticated visual images provide system training for operators and
officers. We specialize in quick responses to requests for unique tailor-made systems from
a wide range of naval customers.

Naval Tactical Trainer

Our
naval tactical trainer, or NTT, is a complete tactical training system providing a
solution for all shore-based tactical training needs. Our NTT is in operational use by the
Israel Navy at its main training base. Our NTT is used for the tactical training of
principal war officers and combat information center officers. In several regions of the
world, this product is also referred to as the Action Speed Tactical Trainer or ASTT.

Our
weapon and avionic systems simulators provide a unique training device for the training of
operators in highly specialized operational tasks. Products delivered to our customers
include the LANTIRN simulator used to train pilots to fly with the LANTIRN pod, and our
weapon systems trainer used to train the weapon systems officer in the many tasks required
to operate and successfully deliver todays complex weapon to the designated target.

# Raw Materials

The
raw materials used for our on-board training systems and our embedded simulation systems
include our own software and commercial off-the-shelf, or COTS, hardware that we purchase
from various suppliers. This COTS hardware includes computer boards, navigational systems,
communication systems and antennae. Due to the competitive nature of the market for these
COTS raw materials, the prices for such raw materials are not considered volatile. In some
countries, however, such raw materials are controlled items and thus, prior to export,
require the issuance of an export license.

The
following table sets forth, for the period indicated, our consolidated revenues by product
line expressed as a percentage of total revenues.

|                                    | 2002 | 2003 | 2004 | 2005 | 2006
|----------------------------------- | ---- | ---- | ---- | ---- | ----
|
|
|
|
|Live and Embedded Training Systems  |      |      |      | 48   | %   
|Virtual and constructive Simulators |      |      |      | 52   | %   
|Total                               |      |      |      | 100  | %   

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# Strategic Relationships

Israel Aircraft
Industries Ltd

From
1992 to 1997, we developed, manufactured and marketed the Ehud ACMI systems pursuant
to a joint venture agreement entered into in 1992 with MLM Systems Engineering &
Integration, or MLM, a division of Israel Aircraft Industries Ltd., or IAI. Pursuant to this agreement, IAI and us agreed to jointly develop, manufacture and
market the Ehud ACMI systems, with IAI subcontracting some of the manufacturing and
integration work with respect to the Ehud product. Following the expiration of the
term of the agreement, various claims were alleged by both IAI and us regarding the
performance of mutual obligations pursuant to the agreement and thereafter. In an ex parte
proceeding filed by IAI, the District Court of Tel Aviv issued in February 1999 a
temporary injunction preventing us from replacing IAI as our subcontractor in a project
for the German Air Force.

In
August 1999, we entered into a cooperation agreement with MLM, which brought an end to
these legal proceedings and established terms for cooperation between the two companies
with respect to the marketing of the Ehud ACMI systems; and in August 2005, we
entered into an additional cooperation agreement with MLM to resolve all other outstanding
disagreements that had remained prior to the signing of this agreement.

The
cooperation agreement of 2005 relates to cooperation with respect to the worldwide
marketing and sale of the Ehud System, R/C and LDN systems, the NCMI System and Electronic
Warfare Training Ranges.

EhudTM
System.The agreement provides for specific territories in which either
we or MLM shall have the exclusive right to act as the leading party and the other party
shall not compete with the leading party in such territories. The leading party shall pay
royalties to the other party at a rate of 5% of the total consideration it receives for
EhudTM System projects in such territories. In other
territories the parties have agreed to a cooperation arrangement pursuant to which one
party shall act as the prime contractor and the other shall act as subcontractor, and each
party shall provide its own proposal relating to its part of the project. Any difference
in price above the joint proposal shall be equally shared between the parties. The
royalties arrangement shall apply in territories not specifically mentioned and agreed
upon between the parties.

R/C
and LDN.In the event of agreements in connection with our R/C system or
MLMs LDN system to a specific customer, the relevant party shall pay the other party
royalties at the rate of 5% of the total consideration. The parties have agreed not to
compete with each other with the R/C system and the LDN system in respect of such
customer.

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NCMI
System. We have agreed to provide MLM, within a reasonable time after the execution of
the agreement, with our existing NCMI infrastructure as a technological base in order to
enable MLM to continue the development of the NCMI system, in consideration for royalties
at the rate of 4% of the consideration of any agreement entered into between MLM and a
customer in respect of a NCMI system. We have also granted MLM a non transferable license,
for the term of the agreement for use of our NCMI infrastructure in certain territories we
will provide up to 30% of the scope of work in such projects. In other territories we have
agreed on a cooperation arrangement in which the prime contractor shall receive 70% of the
consideration and the subcontractor 30% of the consideration and in the event the
subcontractor is granted less than 30% it is compensated at a rate of 1% of the total
consideration for each 4% of the total consideration not subcontracted to the other party.

Electronic
Warfare Training Range. It was agreed that in agreements for the supply of Electronic
Warfare Training Ranges in specific agreed territories MLM shall serve as the prime
contractor and shall enter into a subcontracting agreement with us providing us 30% of the
scope of work.

The
cooperation agreement is valid for ten years and replaced all prior agreements between the
parties relating to its subject matters.

# Other Strategic
Agreements

In
2006, we entered into a settlement agreement with a European aircraft company pursuant to
claims made by us of potential patent infringements by the aircraft company. Under the
settlement agreement, we waived all claims against the aircraft company and granted it a
non-exclusive license to certain of our patents in exchange for royalty payments. The
aircraft company shall pay us an agreed royalty payment for each aircraft sold which
includes embedded simulation by it or any of its affiliates that use any of the licensed
patents.

# Marketing

We
actively seek to identify and propose solutions for military training and simulation needs
of the current and prospective customers. Our research and development activities focus on
systems designed to meet specific needs we identified. We market our products, either as a
prime contractor or as a subcontractor, to various governments and defense contractors
throughout the world directly and through joint ventures, agents or representatives. We
have entered into cooperation agreements with a number of defense contractors, which
provide for joint participation in pursuit and performance of contracts in certain
countries.

In
June 1998, we formed a subsidiary in Singapore, BVR-S Pacific PTE, through which we
support our operations in Singapore.

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The
following table sets forth the amount of our revenues, for the periods indicated, by
geographic regions:

|             | Year Ended December 31,
|------------ | -----------------------
|
|
|
|
|
|Sales        |                        
|Israel       |                        
|Asia Pacific |                        
|Europe       |                        
|America      |                        
|Africa       |                        
|             |                        
|Total        |                        
|             |                        

# Customers

Currently,
all of the end-user customers of our products are governments or companies that are
regulated by government laws and regulations with respect to their military businesses.

Although
the composition of our customers has changed from year to year, and revenues from
individual customers are subject to material increases and decreases depending on customer
requirements, a customer located in Europe accounted for approximately 18% of our revenues
in fiscal 2006, 5% of our revenues in 2005, 8% in 2004 and represented 1% of our backlog
as of December 31, 2006. A customer located in Israel accounted for approximately 17% of
our revenues in fiscal 2006, 2% of our revenues in 2005, 0% in 2004 and represented 1% of
our backlog as of December 31, 2006. Another customer located in Europe accounted for
approximately 16% of our revenues in fiscal 2006, 2% of our revenues in 2005, 3% in 2004
and represented 14% of our backlog as of December 31, 2006. One of our customers located
in Asia Pacific accounted for approximately 12% of our revenues in fiscal 2006, 15% in
fiscal 2005, 27% of our revenues in fiscal 2004, and represented approximately 51% of our
backlog as of December 31, 2006. Another customer located in Europe accounted for
approximately 0% of our revenues in fiscal 2006, 31% in 2005 and 2% of our revenues in
2004 and represented 0% of our backlog as of December 31, 2006. A customer located in
Latin America accounted for approximately 5% of our revenues in fiscal 2006, 11% in 2005
and 34% of our revenues in 2004, and represented approximately 0% of our backlog as of
December 31, 2006. Another customer located in Asia Pacific accounted for approximately 2%
of our revenues in fiscal 2006, 14% in 2005 and 0% of our revenues in fiscal 2004 and also
represented approximately 5% of our backlog as of December 31, 2006. We expect that sales
of our products to a small number of customers will continue to account for a substantial
percentage of our net revenue in the foreseeable future.

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# General Financial
Considerations for Projects

A
significant majority of our contracts are fixed-price contracts, as opposed to
cost-plus-type contracts. Under fixed-price contracts, the price is generally not subject
to adjustment for costs actually incurred in the performance of such contract. Under such
fixed-price contracts, we assume the risk that increased or unexpected costs may reduce
our profits or generate a loss.

There
are various types of financing terms applicable to defense contracts. In most cases, after
we receive advance payment at the commencement of a project, we receive progress or
milestone payments according to a percentage of cost incurred in performance or
achievement of a specific milestone. In these projects we are required to provide a bank
guarantee in an amount equal to the payments. In a majority of projects, we are required
to provide performance guarantees in an amount equal to a specific percentage of the
contract price. A portion of our agreements with customers contains clauses that impose
penalties or reduce the amount payable to us in the event that the completion of a phase
of work is delayed. We are generally responsible for the delays and defaults of our
subcontractors. Accordingly, we attempt to impose liability on our subcontractors on a
back-to-back basis when delay or default under a contract could expose us to
liability.

Our
contracts with governments generally may be terminated or suspended as a result of factors
which may not depend on us, such as a state of war, force majeure or other circumstances
seriously disrupting the public safety, peace or good order of the customers
country. Our contracts with non-governmental military contractors sometimes contain
similar provisions. In cases in which we receive advanced payments prior to incurring the
cost of fulfilling the contract, we realize a positive project cash flow. In the last
three years, we received substantial advances from our customers under a portion of our
contracts. In the event that a contract under which an advance or progress payment has
been paid is cancelled, we may be required to return a portion of such payments to the
customer. In general, in order to reduce risks of financial exposure resulting from an
early termination of a contract, we attempt to expend funds for projects in accordance
with the rate of performance. Upon such termination, we would, in most cases, be entitled
to reimbursement for incurred contract costs and to payment of a proportionate share of
our fee or profit for the portion of such contract that was actually performed. If,
however, we are not entitled to all or a portion of such compensation, our operations
would be adversely effected. In certain cases, when possible, we insure ourselves against
such risks.

# Manufacturing and
Suppliers

We
develop the majority of the software and hardware for our products at research and
development facilities in two locations in Israel. We manufacture cockpit replicas, turret
replicas and other hardware components and perform hardware integration, systems assembly,
and quality assurance testing at our manufacturing facilities in Ashdod, Israel. We
purchase components for the systems manufactured, including commercial computers,
integrated circuits, circuit boards, sheet metal fabricated into subassemblies and
cabinets, power supplies, television monitors and floppy disc drives. Many of the
purchased components are manufactured based on our designs and specifications. Most
materials and purchased components are generally available from a number of different
sources.

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# Competition

We
operate in a competitive environment with respect to most of our products. The defense
industry has been characterized in recent years by a consolidation of companies, which has
decreased the number, but increased the relative size and resources of competitors.
Competition is based on price, product performance, reputation, reliability, maintenance
costs and responsiveness to customer requirements, including the ability to respond to
changing technology. Some of the companies with which we compete, such as divisions of
Thales, Lockheed-Martin, L-3 Communications, Cubic, IAI (in some countries), Elbit Systems
and CAE, have substantially greater financial, marketing and other resources than ours and
have the ability to develop and market products competitive with ours. We believe that our
products favorably compete with those of our competitors based on their technological
capabilities, price/performance ratio, proven track record and common technological
platform. We also believe that our competitive advantage is in our relatively small size
that enables us to be more flexible and responsive to customer requirements than our
larger competitors. In addition, we assume that we typically have lower overhead costs
than our larger competitors.

# Research and Development

The
majority of our research and development activity is performed as an inherent part of our
various projects. In addition, we believe that continued and timely development of new
products and enhancements to existing products is necessary to compete effectively.
Accordingly, through our ongoing and extensive research, development and engineering
activities, we devote a portion of our resources to: (i) sustaining and upgrading our
existing products by improving serviceability and adding new capabilities and features,
(ii) decreasing the cost of owning and operating such products,
(iii) maintaining close relationships with our customers to identify their product
needs, (iv) developing new products with improved capabilities to address such needs
and other military training, debriefing and communications needs identified by us,
(v) adapting our products to new evolving technologies that can lower the costs of
our products; and (vi) tailoring our products to meet the specific needs of our
customers.

Our
internally financed expenditures for all research and development programs during fiscal
2006, 2005 and 2004 totaled approximately $0.6 million, $0.6 million and $0.3 million,
respectively, and represented 6%, 3% and 2% of our revenue, respectively. Royalty-bearing
grants received in the past from the Office of the Israeli Chief Scientist, or OCS, for
research and development were offset against our research and development costs. In fiscal
2006, 2005 and 2004, we did not receive any grants from the OCS. We expect that we will
continue to commit resources to research and development in the future

26

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# Intellectual Property

In
order to protect our proprietary rights and technology used in our products, we rely
primarily upon a combination of patents, trademarks and copyrights as well as on
unpatented proprietary know-how, trade secrets, and various confidentiality and other
agreements with employees, consultants and others, to protect our trade secrets and
know-how. These methods, however, may not afford complete protection and we cannot be sure
that others will not independently develop products including our trade secrets and
know-how or obtain access thereto.

BVR
has five United States patents relating to the collision warning and the data link
features incorporated in our Ehud systems, the animation technology incorporated in
our simulators and our airborne avionics simulator technology. Several of these patents
were also granted or applied for in Israel and/or in specific countries in the European
Community and worldwide.

Our
trademark Atas, was registered in Israel, Europe and Turkey. Our trademark
Ehud, jointly-owned with IAI, was recently registered in several
AsianPacific countries, and we have applied for its registration in Israel, the
European Community and several other foreign countries.

As
part of our cooperation agreement with IAI, IAI and us have each granted the other party a
license to use all patents and other intellectual property rights owned by the other party
relating to the Ehud ACMI system, as is required to enable such party to exercise
its rights under the cooperation agreement. We further agreed to jointly own with IAI the
trade name Ehud. See Item 4  Information on the Company  B.
Business Overview  Strategic Relationship.

C.
Organizational Structure

We
are controlled by Chun Holdings L.P., which, assuming the exercise of its warrants to
purchase 10,864,444 ordinary shares and assuming no other exercise of our convertible
securities, beneficially owns 54.03% of our currently outstanding ordinary shares.

We
hold 100% of the issued and outstanding share capital of BVR-S Pacific PTE, which is
incorporated under the laws of Singapore.

D.
Property, Plant and Equipment

Our
executive offices and research and development facilities are located in Rosh
Haayin, Israel. At this location, in 2006, we leased approximately 2,539 square
meters of office space at a monthly rent of approximately $23,000. This lease will expire
on September 14, 2009. See also Note 16B to our Consolidated Financial Statements.

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We
lease approximately 875 square meters of manufacturing facilities in Ashdod, Israel for a
monthly rent of approximately $11,000. This lease will expire on October 31, 2007.

We
believe that our facilities are suitable and adequate for our operations as currently
conducted. In the event that additional facilities will be required, we believe that we
could obtain such facilities at commercially reasonable rates.

|ITEM 5. | Operating
and Financial Review and Prospects
|------- | --------------------------------------------

The
following discussion of our financial condition and results of operations should be read
in conjunction with the Consolidated Financial Statements and the related notes included
elsewhere in this annual report. This discussion contains forward-looking statements
that involve risks and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors, including,
but not limited to, those set forth in Item 3. Key Information D. Risk
Factors.

# General

We
are engaged in the development, manufacture and marketing of sophisticated training and
computer-based simulation systems for military applications.

Most
of our revenues are generated in U.S. Dollars, and a significant proportion of our
expenses is incurred in U.S. Dollars, or is linked to the U.S. Dollar. Consequently, we
use the U.S. Dollar as our functional currency. Transactions and balances originally
denominated in U.S. Dollars are presented in the financial statements in their original
amounts, and non-dollar transactions and balances have been translated into U.S. Dollars
using the exchange rates in effect on the date of a transaction or balance. Our
Consolidated Financial Statements have been prepared in accordance with Israel GAAP.
Israel GAAP, as applicable to our financial statements, differs in certain significant
respects from U.S. GAAP. See Note 21 to our Consolidated Financial Statements.

We
derive a substantial portion of our revenues from government contracts, the majority of
which are fixed-price, as opposed to cost-plus type contracts. Under fixed-price
contracts, the price is generally not subject to adjustment for costs actually incurred in
the performance of the contract.

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In
most of our projects, we receive advance payment at the commencement of the project and
progress or milestone payments according to our performance or achievement of specific
milestones. In these cases, the advance payments that we receive prior to incurring the
cost of fulfilling the contract create a positive project cash flow. In the last three
years, we have received substantial advances from our customers under a portion of our
contracts. Our contracts generally may be terminated or suspended as a result of factors
which may not depend on us, such as a state of war, force majeure, or other
circumstances seriously disrupting the public safety, peace or good order of the
customers country. In the event that a contract under which an advance or progress
payment has been paid is canceled, we may be required to return such payments or portion
of them to the customer.

We
generally attempt to extend funds for projects in accordance with the rate of performance
in order to reduce risks of financial exposure resulting from an early termination of a
contract. Upon such termination, we would, in most cases, be entitled to reimbursement for
our incurred contract costs and to payment of a proportionate share of our fee or profit
for the work actually performed.

Revenues
related to work in progress under long-term contracts are recognized according to the
percentage-of-completion method. The percentage of completion method is computed-based on
the projects total execution costs which reflect the progress of its completion, and
which include: salaries, material costs and subcontractor charges. Revenues ascribed to
each period are the amounts of gross profits earned on such contracts during such period
plus the costs incurred during such period, excluding cost of materials that have not yet
been used and costs incurred for subcontracted work that is still to be performed).

With
respect to the sale of products acquired from third parties as shelf products and where
the cost of adaptation thereof for a customers specific needs is not material, the
related revenue is recognized after completion and delivery. Provision for estimated
losses on uncompleted contracts are made in the period in which such losses are first
determined in the amount of the estimated loss on the entire contract. Royalty revenues
are generally recorded on a cash basis.

# Critical Accounting
Policies

The
preparation of our financial statements, in conformity with Israeli GAAP, requires us to
make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting period.
These are our managements best estimates based on experience and historical data.
Actual results could differ from those estimates.

Certain
specific accounting policies we utilize require higher degrees of judgment than others in
their application. These include going concern, revenue recognition on long-term contract
work and income taxes. In addition, Note 2 to our Consolidated Financial Statements
includes a further discussion of our significant accounting policies.

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Stock-Based compensation

As
of January 1, 2006, our financial statements comply with Accounting Standard No. 24,
Share-Based Payments which requires our share-based payment transactions,
including transactions with employees or other parties that are to be settled by equity
instruments, cash or other assets, to be recognized in our financial statements. Standard
No. 24 requires the restatement of comparative data relating to periods after March 15,
2005. As of December 31, 2005, the charge for equity-settled share-based payments in the
consolidated income statement is approximately $7,000.

Going Concern

The
application of the going concern basis of accounting involves a range of subjective
judgments, principally in relation to the sufficiency of our resources to allow us to
continue to operate in the ordinary course and thereby realize our assets and discharge
our liabilities in the normal course of business for a period of 12 months following the
approval date of the consolidated financial statements. These resources are derived from
working capital, cash flow, volume of orders obtained, backlog of orders, existing cash
balances together with meeting forecasted cash flows from operating activities, as well as
obtaining orders forecasted in the budget.

Revenue Recognition

We
account for our revenues on fixed price long-term contract work on the percentage of
completion method. This method of accounting requires us to calculate project profit to be
recognized in each reporting period for each project based upon our predictions of future
outcomes which include estimates of the total cost to complete (such as assumptions
relative to future labor performance and costs, materials costs and subcontractor charges)
and estimates of project schedule and completion date.

At
the onset of each contract, we prepare a detailed analysis of our estimated cost to
complete the project. Our project personnel evaluate the estimated costs at the project
level. Significant projects are reviewed in detail by senior management on a quarterly
basis.

Our
estimates of revenues and expenses on long-term contracts could change periodically in the
normal course of business. Such changes would be reflected in results of operations as a
change in accounting estimate in the period the revisions are determined. For all the
contracts, provisions for estimated losses on uncompleted individual contracts are made in
the period in which such losses are first determined, in the amount of the estimated loss
on the entire contract.

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Income Taxes

As
part of the process of preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This process
requires us to estimate our actual current tax exposure and make an assessment of
temporary differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which are
included within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income and, to the extent we
believe that recovery is not likely, we must establish a valuation allowance. To the
extent that we establish a valuation allowance or increase this allowance in a period, we
must include an expense within the tax provision in the statement of operations.
Significant management judgment is required in determining our deferred tax assets and
liabilities and any valuation allowance recorded against our net deferred tax assets. We
have a valuation allowance of $12 million as of December 31, 2006, which is equal to the
value of the deferred tax asset consisting primarily of our net operating loss carry
forwards. This indicates our managements current assessment that because we are yet
to generate taxable income, we cannot determine whether it is likely that we will be able
to use this asset in the future. In the event that we generate taxable income in a
particular jurisdiction in which we operate and in which we have net operating loss
carry-forwards, we may be required to adjust our valuation allowance.

# A. Results of Operations

The
table below sets forth, for the periods indicated, financial data, expressed as a
percentage of total revenues that we believe to be significant in analyzing our results of
operations. The data is as follows:

|                                               | For Years Ended December 31,
|---------------------------------------------- | ----------------------------
|
|
|
|
|Revenues                                       |                             
|Cost of revenues                               |                             
|Gross profit (loss)                            |                             
|Research and development                       |                             
|Selling, general and administrative
  expenses |                             
|Operating profit (loss)                        |                             
|Financing expenses, net                        |                             
|Other income (expenses), net                   |                             
|Profit (loss) before income taxes              |                             
|Income tax (expenses) benefits                 |                             
|Net Profit (loss)                              |                             

Our order backlog as of December 31,
2006 was $22 million.

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# Subsequent Events

| |  | There
are no substantial events subsequent to December 31, 2006.
| | - | ----------------------------------------------------------------

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

Revenues.

Revenues
in fiscal 2006 were $10.1 million, a decrease of 47% compared to revenues of $19.2 million
in fiscal 2005. The decrease was primarily attributed to the completion of several
significant projects in 2005, particularly to the progress achieved during 2005 in one
significant project in Europe, which contributed $6.0 million to the revenues of fiscal
2005. In addition, according to the agreement signed with IAI on August 2005, we have
received royalties from IAI amounting to $1.7 million during 2005. Revenues from sales of
our live and embedded training systems products in fiscal 2006 accounted for 56%, compared
to 64% of our revenues in fiscal 2005. Revenues derived from our virtual and constructive
simulator products accounted for 44% of our revenues in fiscal 2006, compared to 36% of
our revenues in fiscal 2005. The geographical breakdown of our revenues in fiscal 2006 was
as follows: approximately 45% of our revenues were in Europe, 23% in Israel, 21% in Far
East and 11% in America. In fiscal 2005, approximately 43% of our revenues were in Europe,
33% in Far East, 16% in America, 6% in Israel and 2% in Africa. The fluctuations in the
proportion of our revenues attributed to geographic areas are the result of the completion
of several contracts, which we had with various countries. Our agreements are multi-year
contracts, and we generally recognize revenues on the percentage of completion method,
recognizing expenses when incurred.

In
fiscal 2005, income from royalties and commissions was $1.7 million pursuant to the
cooperation agreement with MLM signed in August 2005 which resolved past disagreements.
During 2006, we recognized income from royalties in the amount of $276,000.

Gross Profit (Loss).

Gross
profit in fiscal 2006 was approximately $2.2 million, a decrease of $2.2 million from a
gross profit of $4.4 million in fiscal 2005. The decrease in gross profit was primarily
due to royalties revenues from IAI amounting to $1.7 million in 2005, together with a $0.8
million decrease in cost of revenue in 2005 as result of a reversal of certain previously
accrued liabilities that are no longer payable as a result of the new agreement signed
with IAI in 2005. Royalties from IAI in 2006 were $0.3 million. In addition, the decrease
in revenues in 2006 in comparison to revenues in 2005 contributed to the decrease in gross
profit. As a percentage of revenues, gross margin did not change significantly from an
overall gross margin of 23% in fiscal 2005, to an overall gross margin of 22% in fiscal
2006. The gross margin from projects improved in 2006 due to higher gross margins in
projects received during the end of 2005 and during 2006. The increase in gross margin in
2006 was offset by increased costs in one of our projects for the completion of the
project. Our gross margin is influenced by various factors, such as the type and size of a
project, and the portion of projects performed by subcontractors.

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Research and Development
Costs.

Gross
research and development expenditures consist primarily of salaries, subcontractors and
other personnel related expenses related to design, development and enhancement of our
products and, to a lesser extent, depreciation and other expenditures. Gross research and
development expenses in fiscal 2006 were $0.6 million, the same as in fiscal 2005. Gross
research and development expenses were primarily attributed to continuing the development
of the EVA and its derivatives.

Selling and Marketing
Expenses.

Selling
and marketing expenditures consist primarily of costs relating to payroll expenses, sales
commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions
and participation in trade shows. Selling and marketing expenditures in fiscal 2006 were
$1.4 million, an increase of $0.1 million, or 5%, from $1.3 million in fiscal 2005. The
increase in selling and marketing expenses was primarily attributed to the fact that we
participated in 2006 in several exhibitions, including the Asian Aerospace Show, the
Farnbourough Airshow and IITSEC, and from increasing our marketing activities for our EVA
and IFEWS products.

General and
Administrative Expenses.

General
and administrative expenses consist primarily of salaries and related costs of welfare and
administration, finance and general management personnel, professional fees, office,
vehicle and rental expenses. General and administrative expenses in fiscal 2006 were $2.2
million, an increase of $38,000, or 2%, from $2.1 million in fiscal 2005. The small
increase in general and administrative expenses was primarily attributed to an increase in
legal fees, professional fees and travel costs relating to our inquiries into a potential
acquisition of a company. This increase was almost offset by a decrease in other
professional fees, including market analysis of the training military market and
management skills improvement, which took place in 2005.

Operating Profit (Loss).

As
a result of the foregoing, we had an operating loss of $(2.0) million in fiscal 2006,
compared to an operating profit of $0.3 million in fiscal 2005. As a percentage of
revenues, operating profit decreased from an operating profit of 2% in fiscal 2005, to an
operating loss of (19%) in fiscal 2006.

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Financial Expenses, Net.

Financial
expenses, net consist primarily of interest paid on loans and bank charges, net of income
from interest earned on short-term deposits and interest on non-current receivables, gains
or losses from derivatives instruments and gains or losses arising from foreign exchange
erosion of monetary balances. Financial expenses, net in fiscal 2006 were approximately
$0.19 million, similar to fiscal 2005. The changes in financial expenses, net were
primarily attributed to a decrease in interest on loans received from banks due to reduced
amounts of loans because of the repayment of loans during fiscal 2005 and fiscal 2006. The
changes were also attributed to an increase in interest income received from cash deposits
due to higher amounts deposited during the year, a decrease in bank charges relating to
guarantees due to a decreased commission rate on guarantees amount, offset by losses from
derivative instruments and foreign exchange losses.

# Year Ended December 31,
2005 Compared to Year Ended December 31, 2004

Revenues.

Revenues
in fiscal 2005 were $19.2 million, an increase of 51% compared to revenues of $12.7
million in fiscal 2004. The increase was primarily attributed to the completion of several
significant projects in 2005, particularly to the progress achieved during 2005 in one
significant project in Europe which contributed $ 6.0 million to the revenues of fiscal
2005. In addition, according to the agreement signed with IAI on August 2005, we have
received royalties from IAI amounting to $ 1.7 million. Revenues from sales of our live
and embedded training systems products in fiscal 2005 accounted for 64% compared to 55% of
our revenues in fiscal 2004. Revenues derived from our virtual and constructive simulator
products accounted for 36% of our revenues in fiscal 2005 compared to 45% of our revenues
in fiscal 2004. The geographical breakdown of our revenues in fiscal 2005 was as follows:
approximately 43% of our revenues were in Europe, 33% in Asia Pacific, 16% in America and
Latin America, 6% in Israel and 2% in Africa. In fiscal 2004, approximately 36% of our
revenues were in Asia Pacific, 21% in Europe, 36% in Latin America and 7% in Israel. The
fluctuations in the proportion of our revenues attributed to geographic areas are the
result of the completion of several contracts which we had with various countries. Our
agreements are multi-year contracts, and we generally recognize revenues on the percentage
of completion method, recognizing expenses when incurred.

In
fiscal 2005, income from royalties and commissions was $1.7 million pursuant to the
Cooperation agreement with MLM signed in August 2005.During 2004, there were certain
disagreements between the company and MLM and as a result no income from royalties and
commissions were recognize .

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Gross Profit (Loss).

Gross
profit in fiscal 2005 was approximately $4.4 million, an increase of $2.0 million from a
gross profit of $2.4 million in fiscal 2004. As a percentage of revenues, gross profit
increased from a gross profit of 19% in fiscal 2004, to a gross profit of 23% in fiscal
2005. The increase in gross profit was primarily due to the increase in royalties revenues
from IAI amounting to $1.7 million, together with $0.8 million decrease in cost of revenue
as result of a reversal of certain previously accrued liabilities that are no longer
payable as a result of the new agreement signed with IAI in 2005. The increase in gross
margin was partially offset by a lower gross margin in one significant project in Europe
with a lower profitability, which contributed $6.0 million to the revenues of fiscal 2005.

Research and Development
Costs.

Gross
research and development expenditures consist primarily of salaries, subcontractors and
other personnel-related expenses related to design, development and enhancement of our
products and, to a lesser extent, depreciation and other expenditures. Gross research and
development expenses in fiscal 2005 were $0.6 million, an increase of $0.3 million or 109%
from $0.3 million in fiscal 2004. The increase in gross research and development expenses
was primarily attributed to the development of the EVA.

Selling and Marketing
Expenses.

Selling
and marketing expenditures consist primarily of costs relating to payroll expenses, sales
commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions
and participation in trade shows. Selling and marketing expenditures in fiscal 2005 were
$1.3 million, an increase of $0.2 million, or 19%, from $1.1 million in fiscal 2004. The
increase in selling and marketing expenses was primarily attributed to the fact that we
participated in 2005 in several exhibitions including the Paris Air Show and Indian Air
Show and from increasing our marketing activities for our Eva and IFEWS products.

General and
Administrative Expenses.

General
and administrative expenses consist primarily of salaries and related costs of welfare and
administration, finance and general management personnel, professional fees, office,
vehicle and rental expenses. General and administrative expenses in fiscal 2005 were $2.1
million, an increase of $0.3 million, or 16%, from $1.8 million in fiscal 2004. The
increase in general and administrative expenses was primarily attributed to bonuses to
employees paid only in fiscal 2005, increases in professional fees includes market
analysis of the training military market and management skills improvement and increase in
travel costs for business development. As a percentage of revenues, general and
administrative expenses in fiscal 2005 were approximately 11% compared to 14% in fiscal
2004.

35

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Operating Profit (Loss).

As
a result of the foregoing, we had an operating profit of $0.3 million in fiscal 2005
compared to an operating loss of $(0.9) million in fiscal 2004. As a percentage of
revenues, operating profit increased from an operating loss of (6%) in fiscal 2004, to an
operating profit of 2% in fiscal 2005.

Financial Expenses, Net.

Financial
expenses, net consist primarily of interest paid on loans and bank charges, net of income
from interest earned on short-term deposits and interest on non-current receivables, gains
or losses from derivatives instruments and gains or losses arising from foreign exchange
erosion of monetary balances. Financial expenses, net in fiscal 2005 were approximately
$0.19 million, a decrease of approximately $0.3 million from approximately $0.5 million in
fiscal 2004. The decrease was primarily attributed to a decrease in interest on loans
received from banks due to reduced amounts of loans because of the repayment of loans
during fiscal 2004 and fiscal 2005 and the conversion of loans to shares during 2004. The
decrease was also attributed to an increase in interest income received from cash deposits
due to higher amounts deposited during the year, a decrease in bank charges relating to
guarantees due to a decrease in the guarantee amount, gains from derivative instruments
and foreign exchange gains.

Other Income (Expenses),
Net.

We
incurred other expenses of approximately $2,000 in fiscal 2005, compared to approximately
$192 thousand net other income in fiscal 2004. The net income in 2004 was primarily
attributed to gain on the forgiveness of a longterm loan from a former related party
in the amount of $177, 000.

# Impact of Inflation and
Devaluation on Results of Operations, Liabilities and Assets

The
dollar cost of our operations is influenced by the extent to which inflation in Israel is
or is not offset, or is offset on a lagging basis, by the devaluation of the NIS in
relation to the dollar. When the rate of inflation in Israel exceeds the rate of
devaluation of the NIS against the dollar, companies experience increases in the dollar
cost of their operations in Israel. Unless offset by a devaluation of the NIS, inflation
in Israel will have a negative effect on our profitability, as we receive payment in
dollars or dollar-linked NIS for all of our sales, while we incur a portion of our
expenses in NIS.

The
following table presents information about the rate of inflation in Israel, the rate of
devaluation of the NIS against the dollar, and the rate of inflation in Israel adjusted
for the devaluation:

|Year ended
December 31 | Israeli inflation %
rate | Devaluation of the NIS
rate % | Israeli inflation adjusted
for devaluation %
|---------------------- | ------------------------ | ----------------------------- | --------------------------------------------
|
|
|
|
|2002                   |                          | 6.5                           |                                             
|2003                   |                          | (1.9                          | )                                           
|2004                   |                          | 1.2                           |                                             
|2005                   |                          | 2.4                           |                                             
|2006                   |                          | (0.1                          | )                                           

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A
devaluation of the NIS in relation to the dollar has the effect of reducing the dollar
amount of any of our expenses or liabilities payable in NIS, unless those expenses or
payables are linked to the dollar. This devaluation also has the effect of decreasing the
dollar value of any asset that consists of NIS or receivables payable in NIS, unless the
receivables are linked to the dollar. Conversely, any increase in the value of the NIS in
relation to the dollar has the effect of increasing the dollar value of any unlinked NIS
assets and the dollar amounts of any unlinked NIS liabilities and expenses.

Because
exchange rates between the NIS and the dollar fluctuate continuously, with a historically
declining trend in the value of the NIS, exchange rate fluctuations, particularly larger
periodic devaluations, will have an impact on our profitability and period-to-period
comparisons of our results.

We
are exposed to a variety of market risks, including changes in interest rates and foreign
currency fluctuations.

We
entered into currency future contracts and put and call option contracts to reduce our
exposure to fluctuations of specific currencies against the dollar, resulting primarily
from firm commitments in such currencies.

As
of December 31, 2006, we had an obligation to sell $200,000 for a total amount of NIS
846,000.

The
fair value of this derivative financial instrument was immaterial.

# Political and Economic
Conditions.

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 the continued state of hostility, varying
in degree and intensity, has led to security and economic problems for Israel. During the
summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese
Islamist Shiite militia group and political party. This conflict involved missile strikes
against civilian targets in northern Israel, and negatively affected business conditions
in Israel. In addition, Israel and companies doing business with Israel have, in the past,
been the subject of an economic boycott. Although Israel has entered into various
agreements with Egypt, Jordan and the Palestinian Authority, Israel has been and is
subject to civil unrest and terrorist activity, with varying levels of severity, since
September 2000. The election in early 2006 of representatives of the Hamas movement to a
majority of seats in the Palestinian Legislative Council and the tension among the
different Palestinian factions may create additional unrest and uncertainty. Any future
armed conflicts or political instability in the region may negatively affect business
conditions and adversely affect our results of operations. We could be adversely affected
by hostilities involving Israel, the interruption or curtailment of trade between Israel
and its trading partners, or a continuous downturn in the economic or financial condition
of Israel. In addition, several countries continue to restrict business with Israel and
with companies having operations in Israel. We could be negatively affected by further
adverse developments in the peace process, including the recent violence, or by
restrictive laws or practices directed towards Israel or Israeli exporters.

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Like
all male adult citizens and permanent residents of Israel, our directors, officers and
employees who are under the age of 45, unless exempt, are obligated to perform up to 36
days of military reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances. The majority of our
officers and employees are currently obligated to perform annual reserve duty. No
assessment can be made as to the full impact of such requirements on our workforce or
business if conditions in Israel should change, and no prediction can be made as to the
effect of any expansion or reduction of such military obligations on us. See Item 4.
Information on the Company  B. Business Overview  Conditions in Israel.

Economic Conditions

Israels
economy has been subject to numerous destabilizing factors, including a period of rampant
inflation in the early to mid-1980s, low foreign exchange reserves, fluctuations in world
commodity prices, military conflicts and civil unrest. The Israeli government has
intervened in various sectors of the economy by utilizing fiscal and monetary policies,
import duties, foreign currency restrictions and controls of wages, prices and foreign
currency exchange rates. The Israeli Government has periodically changed its policies in
all these areas.

# Effective Corporate Tax
Rate

Israeli
companies are subject to corporate tax on their income, at a rate which will be gradually
reduced from the rate of 31% in 2006, to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in
2010 and thereafter.

However,
our old manufacturing facilities in Jerusalem and our facilities in Rosh Haayin have
been granted Approved Enterprise status under the Law for the Encouragement of
Capital Investments, 1959, as amended, known as the Investment Law. Consequently, these
facilities are eligible, subject to compliance with specified requirements, for tax
exemption for a period of two years and reduced tax rate of 25% for an additional period
of five years on our increased income, if any, commencing on the day we derive taxable
income from our facilities in Rosh Haayin. We may utilize such tax benefits until
2016. The tax benefits under the Investment Law are not available with respect to income
derived from products manufactured outside of Israel. We expect to derive a substantial
portion of our income from our Approved Enterprise facility.

38

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# B. Liquidity and Capital
Resources

Historically
we have met our financial requirements primarily through the private sale of equity
securities, customer payments and advances and the utilization of bank credit lines. In
addition, we raised capital through equity financings in 2004 and in 2006. As of
December 31, 2006, we had cash and cash equivalents of approximately $3.4 million and
a positive working capital of approximately $3.4 million.

On
April 20, 2004, we reached an agreement with a former related party for the repayment of
$204,000 out of an outstanding loan amounting to $381,000 resulting in the forgiveness of
a debt amounting to $177,000.

Pursuant
to these transactions, the banks agreed to postpone repayment of $1.5 million in
short-term credit, such that $0.5 million is repayable in each of the years 2005, 2006 and
2007. The first payment was paid in January 2005, the second payment was paid in January
2006 and the third payment is scheduled to be made in January 2007.

There
are no restrictions as to our use of the credit lines with our banks. The banks may
terminate our credit lines at any time, and the banks may demand repayment in full of any
indebtedness then outstanding.

In
addition, we have obtained bank guarantees to secure our performance of certain
obligations, including under our leases and contracts with customers. Of these guarantees,
which amounted to an aggregate of $12.1 million on December 31, 2006, guarantees in an
aggregate of $11.5 million are to be released by our obtaining specific performance
milestones, which are scheduled to be completed through October 2012.

In
connection with our guarantees, loans and credit lines from banks, we have placed equally
ranking, first priority fixed and floating liens on all of our assets.

Our
operating cash flow is influenced by cash provided from our customers as an advance and by
cash used in the performance of ongoing projects. Operating activities for the year 2006,
2005 and 2004, provided (or used) cash of approximately ($2.4) million, $1.0 million and
($1.9) million, respectively. For fiscal 2006, cash derived from changes in assets and
liabilities of ($0.8) million primarily consisted of an increase in trade receivables of
($2.9) million. Additionally, there was an increase in excess of advances from customers
over amounts recognized as revenues of $2.1 million.

For
fiscal 2005, cash provided from changes in assets and liabilities of $0.5 million
primarily consisted of a decrease in trade receivables of $2.4 million. Additionally,
there was a decrease in excess of advances from customers over amounts recognized as
revenues of $(2.4) million, a decrease in inventory of $1.2 million, a decrease in trade
payables of ($0.6) million and a decrease in other payables and accrued expenses of $0.2
million.

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For
fiscal 2004, changes in operating assets and liabilities of $0.9 million primarily
consisted of a decrease in trade payables of $1.1 million. Additionally, there was a
decrease in trade receivables of $0.2 million, a decrease in other receivables and prepaid
expenses of $0.4 million, a decrease in inventory of $0.2 million and a decrease in other
payables and accrued expenses of $0.3 million.

Investing
activities for fiscal 2006, fiscal 2005 and fiscal 2004 used cash of approximately ($0.2)
million, ($0.1) million and ($2.7) million, respectively. Cash flows used in investing
activities in fiscal 2006 consisted primarily of a purchase of fixed assets in the amount
of $0.3 million and a decrease in restricted bank deposits of $0.3 million and an increase
in other assets in the amount of $0.3 million. The decrease in restricted bank deposits
was due to a decrease in advanced payments and performance guarantees. .

Cash
flows used in investing activities in fiscal 2005 consisted primarily of a purchase of
fixed assets in the amount of $0.3 million and a decrease in restricted bank deposits of
$0.2 million. The decrease in restricted bank deposits was due to a decrease in advanced
payments and performance guarantees.

Cash
flows used in investing activities in fiscal 2004 consisted primarily of an increase in
restricted bank deposits of $2.6 million and purchase of fixed assets in the amount of
$0.1 million. The increase in restricted bank deposits was due to an increase in advance
payment and performance guarantees.

Financing
activities for fiscal 2006, fiscal 2005 and fiscal 2004 provided (or used) cash of
approximately 3.1 million, ($0.5) million and $5.7 million, respectively.

Cash
flows used in financing activities in fiscal 2006 consisted primarily of share and warrant
issuances in the amount of $3.6 million and the net repayment of long-term loans from
banks of $0.5 million.

Cash
flows used in financing activities in fiscal 2005 consisted primarily of the net repayment
of long-term loans from banks of $0.5 million.

Cash
flows provided by financing activities in fiscal 2004 consisted primarily of the issuance
of ordinary shares and options in consideration for $9.7 million, the exercise of $3.1
million in stock options and the net repayments of $6.6 million, $0.4 million and $0.2
million, respectively, with respect to a short-term bank credit, a short-term loan from
Chun and long-term loans from former shareholders.

Our
current assets exceed our current liabilities. We believe that the existing cash balances
together with meeting forecasted cash flows from operating activities for fiscal 2007, as
well as obtaining orders forecasted in the budget approved by the Board of Directors will
be sufficient to meet our present working capital and capital expenditure needs.

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# C. Research and
Development, Patents and Licenses

See
"Item 4 - Information on the Company - B. Business Overview - Research and Development;
Intellectual Property."

# D. Trend Information

# Periodic Variations in
Operating Results

Due
to the nature of our customers and products, our sales are often made pursuant to a
relatively small number of customers and large orders. Consequently, an individual project
from an individual customer can represent a substantial portion of our revenues in any one
period. In addition, a significant project for any customer during one period may not be
followed by further projects for the same customer in subsequent periods. Our sales and
operating results may, therefore, vary substantially from period to period. In 2003, we
experienced a significant increase in orders from Latin American countries. This would
appear to be the result of our having invested substantial amounts of our time and
resources from 2001, in developing a market that we believe to have significant commercial
potential. In 2004, we successfully entered into a significant contract with a Portuguese
entity pursuant to diligent marketing efforts. In 2005, we successfully entered into a
significant contract with an Israeli company regarding a purchase order made by the Israel
Air Force. In 2006, we successfully entered into five significant contracts with two major
European companies and three foreign customers.

# Delay in the Receipt of
Required Export Approvals

We
purchase from manufacturers in the United States a portion of the commercial computers, a
portion of the air combat maneuvering instrumentation pods hardware and other
off-the-shelf products, such as navigation systems, which we incorporate into
our products. The export of such components is subject to the approval of the United
States Department of Commerce and/or the United States Department of Defense, which often
restricts sales to certain countries. Since the events of September 11, 2001, the United
States has imposed a longer bureaucratic process on the provision of approvals and has
attached more stringent conditions; consequently, we have experienced delays in the
receipt of such required approvals.

# E. Off-Balance Sheet
Arrangements

We
do not have any off-balance sheet arrangements.

# F. Tabular Disclosure of
Contractual Obligations

Our significant
financial and contractual obligations as of December 31, 2006, and the periods in
which such obligations are due are as follows:

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Payments and Amount of Commitment 
Expiration Per Period
(U.S. Dollars in Thousands)

|Contractual Obligations(1)   | Total
Amounts
Committed | Less than
1 Year | 1-3 Years | 3-5 Years | More than 5
Years
|---------------------------- | ----------------------- | ---------------- | --------- | --------- | -----------------
|
|
|
|
|Borrowed Lines of credit     |                         |                  |           | 636       |                  
|                             |                         |                  |           |           |                  
|Guarantees:                  |                         |                 
|Performance guarantees       |                         |                  |           | 6,087     |                  
|Advance payment guarantees   |                         |                  |           | 5,423     |                  
|Other bank guarantees        |                         |                  |           | 602       |                  
|                             |                         |                  |           |           |                  
|Total Guarantees             |                         |                  |           | 12,112    |                  
|                             |                         |                  |           |           |                  
|Operating lease commitments  |                         |                  |           | 876       |                  
|                             |                         |                  |           |           |                  
|Total commercial commitments |                         |                  |           | 13,624    |                  
|                             |                         |                  |           |           |                  

(1)
          Excludes liability for employee severance benefits, net in the amount of
          $166,000 and long term payable in respect of income taxes of $154,000.

# G. Safe Harbor

Not
applicable.

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|ITEM 6. | Directors,
Senior Management and Employees
|------- | ------------------------------------------

# A. Directors and Senior
Management

The
following table lists the name, age and position held by each of our executive officers
and directors, as of March 31, 2007:

|Name             | Age | Position
|---------------- | --- | --------
|
|
|
|
|Aviv Tzidon      |     |         
|                 |     |         
|Avi Leumi        |     |         
|Uri Manor        |     |         
|                 |     |         
|Avraham Gilat    |     |         
|Rimon Ben-Shaoul |     |         
|Gadi Aviram      |     |         
|Orit Stav        |     |         
|Amnon Harari     |     |         
|Ken Lalo         |     |         
|Nir Dor          |     |         
|Ilan Gillies     |     |         
|Reuven Shahar    |     |         
|Dekel Tzidon     |     |         
|Gilad Yavets     |     |         

---

|*External
Director
|------------------

Aviv
Tzidon has been a Director and the Chairman of our Board of Directors since
November 24, 2003. Mr. Tzidon was the co-founder of BVR Technologies Ltd. (or BVR-T) and
served as its Chief Technology Officer and a director since it commenced operations in
1987. From October 1998, upon the spin-off of BVR Systems (1998) Ltd. from BVR-T, and
until April 2000, Mr. Tzidon served as Chairman of the Board of Directors and Chief
Executive Officer of BVR-T. For three years, Mr. Tzidon worked as an independent
consultant for Israel Aircraft Industries. Mr. Tzidon served as a combat pilot with the
Israel Air Force, including reserve service, for approximately 20 years.

Avi
Leumi has been a Director since March 1, 2004. Mr. Leumi has served as CEO,
Co-Founder and Chairman of the Board of Directors of Aeronautics Defense Systems Ltd.
since November 1997. From 1992 to 1997, Mr. Leumi served as CEO of Leumi Chemicals Ltd., a
family owned business. Mr. Leumi is a graduate of the Israel Naval Academy.

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Uri
Manor has been a director since March 1, 2004. Mr. Manor has served as
Managing Director of Datus Ltd., a consulting company specializing in the marketing of
defense systems since January 1, 1996 and Managing Director of Loven Hachatzav Ltd., a
holding company specializing in high tech and defense companies since 2001. Mr. Manor is
also a member of the board of directors of Soltam Systems, Fibrotex International and
Aeronautics Defense Systems Ltd.. Moreover, Mr. Manor represents Hindustan Aeronautics
Limited in Israel. From 1969 to 1996, Mr. Manor held various management positions in
Israel Aircraft Industries Ltd. including Deputy General Manager, MBT Division. Mr. Manor
holds a B.Sc. and an M.Sc. in Aeronautical Engineering from the Technion, the Israel
Institute of Technology.

Avraham
Gilat has been a director since June 28, 2005. Mr. Gilat serves as the
Chairman of Soltam Systems Ltd. and the Soltam Group, one of Israels prominent
defense companies and as a Director General of Mikal Ltd., a holdings company for a wide
range of commercial activities. Prior to this Mr. Gilat served in various positions in
Israel Military Industries Ltd. Mr. Gilat holds an M.B.A. from New York University and a
B.A. in Economics from Tel-Aviv University.

Rimon
Ben-Shaoul has been a director since March 1, 2004. Since 2004, Mr.
Ben-Shaoul has served as President and Chief Executive Officer of Polar Communications
Ltd., an investment company investing in the technology and telecommunications sectors,
and as chairman or a member of the Board of Directors of various private and publicly
traded companies within the Polar group. Since February 2001, Mr. Ben-Shaoul has also
served as Co-Chairman, President and Chief Executive officer of Koonras Technologies Ltd.,
an investment company controlled by Polar Investments Ltd. From June 1997 to February
2001, Mr. Ben-Shaoul served as President and Chief Executive Officer of Clal Industries
and Investments Ltd., one of Israels largest holdings companies in the industrial
and high-tech sectors, and as a member of the Board of Directors of Clal (Israel) Ltd. and
various subsidiaries thereof. From 1985 to June 1997, Mr. Ben-Shaoul served as President
and Chief Executive Officer of Clal Insurance Company Ltd., was a member of its board of
directors and served as Chairman or as a member of the board of directors of various
subsidiaries of Clal Insurance Company Ltd. Mr. Ben-Shaoul holds an M.B.A. and a B.A. in
Economics from Tel-Aviv University.

Gadi
Aviram has been a director since March 1, 2004. Mr. Aviram is the founder
and Chief Executive Officer of Metro Motor Marketing Ltd., local importer and
representative of Kawasaki Heavy Industries. From 2000 to 2002, Mr. Aviram served as
director of Safecom Car Communication Ltd. and from 1999 to 2000, Mr. Aviram served as
director of Pointer (Eden Telecom Group) Ltd.

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Orit
Stav has been one of our external directors since March 1, 2004. Ms. Stav
is an Investment Associate at Siemens Venture Capital. Prior to joining Siemens VC, Ms.
Stav was a partner in Platinum Neurone Ventures (PNV), an Israeli Venture Capital Fund and
has more than six years of experience in the venture capital market and the technology
industry in Israel. She led investments from seed stage to exit and worked with leading
international VCs. She gained experience with varied technology companies throughout the
Siemens investment spectrum. Ms. Stav holds a B.A. in Economics and Management from Tel
Aviv University and an M.B.A. from Hertfordshire University, UK.

Amnon
Harari has been one of our external directors since July 2002. Mr. Harari
currently serves as the Vice President of sales and service for EMEA in Lumenis Ltd. From
March 2002 until August 2004, Mr. Harari served as the Chief Executive Officer of Advanced
Heating Technologies Ltd. From May 2000 to March2002, Mr. Harari served as Chief
Executive Officer of Partner Future Communication Ltd. From April1999 to April2000, Mr. Harari served as General Manager of Alcatel Israel. From April1997
to April1999, Mr. Harari served as Corporate Vice-President and General Manager of
the Public Switching Division of Tadiran Telecommunication Ltd that was later acquired by
Alcatel to become Alcatel Israel. From 1992 to 1996, Mr. Harari served as the head of the
Israel Air Force Material Directorate. From February1997 to February 2002, Mr.
Harari served as an External Director of Elbit Systems Ltd. Mr. Harari is a
Brigadier-General in the Israel Air Force. Mr. Harari holds a B.Sc. in Physics from the
Tel Aviv University.

Ken
Lalo has been a director since February 20, 2006. Since 2004, Mr. Lalo has
served as Executive Vice President of Polar Communications Ltd., an investment company
controlled by Polar Investments Ltd. and is a member of the Boards of Directors of various
affiliates of Polar, including publicly traded and private companies. Between 2001 and
2004, Mr. Lalo served as Vice President and General Counsel of other entities within the
Polar Investments group. From 1993 to 2001, Mr. Lalo served as Vice President and General
Counsel of Clal Industries and Investments Ltd. and was a member of the Boards of
Directors of various affiliates of Clal, including publicly traded and private companies.
From 1986  1992, Mr. Lalo worked as an attorney in Maryland, USA. Mr. Lalo holds an
M.B.A. from Northwestern University / Tel- Aviv University, an M.C.L. from George
Washington University and an LL.B. from Tel-Aviv University.

Nir
Dorhas been a director since March 21, 2006. Mr. Dor currently serves as the chairman
of the board of directors of Cargal Carton Industries Ltd., Vice Chairman of the board of
directors of Global Factoring Ltd. and serves on the board of directors of The Danone
Spring of Eden BV. Mr. Dor served as the chief executive officer of Eden Springs Ltd.
between 1999 and 2004. Mr. Dor is a certified public accountant and holds a B.A. in
business management and finance from the College of Management of Tel-Aviv.

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Ilan
Gillies has been our Chief Executive Officer since his appointment on
November 26, 2003. Mr. Gillies has been employed by the BVR Group since 1995 and served as
Managing Director of BVR S Pacific from November1998 to September 2003. Mr. Gillies has
served as a combat pilot with the Israel Air Force since 1989.

Reuven
Shaharhas been our Chief Financial Officer and Vice President of Finance
since his appointment on July 1, 2000. From 1995 through June 2000, he was Treasurer and
Director of Finance of Elisra Electronic Systems Ltd. From 1990 to 1995, Mr. Shahar was
the head of the economic staff in the defense division of Elisra. He previously held
various positions at Elisra as of 1984. Mr. Shahar holds a B.A. in business management
from the Hebrew University of Jerusalem and an M.B.A. from Recanati Graduate School of
Business Administration in Tel Aviv University.

Dekel
Tzidon has been our Chief Technology Officer and Vice President of Research
& Development since January 1, 2004. From 1995 to 1997, Mr. Tzidon was employed by
RTSET as an R&D engineer and IP manager. In 1997, Mr. Tzidon joined BVR as a senior
systems engineer, IP manager and head of the technology group. In 2001, Mr. Tzidon served
as a senior systems engineer in Comview. Since 2002, Mr. Tzidon has been employed as an IP
consultant for a number of hi-tech companies including BVR. Mr. Tzidon has a B.Sc. in
computer engineering. Mr. Tzidon is the brother of Mr. Aviv Tzidon, the Chairman of our
Board of Directors.

Gilad
Yavetshas been our Vice President of Marketing since March 3, 2004. Mr.
Yavets joined BVR in 1997 and has served in different positions in the company, including
Contracts Director, Director of Business Development and Acting Vice President of
Marketing. Mr. Yavets holds an LL.B. from the Faculty of Law of the Hebrew University of
Jerusalem and an Executive M.B.A. from the Recanti Graduate School of Business
Administration in Tel-Aviv University.

Expiration of Term of
Office

No
term of our external directors has expired, in accordance with the provisions of the
Israel Companies Law  1999, as amended from time to time (the Companies Law). On
June 28, 2005, our shareholders extended Mr. Hararis appointment to continue to
serve as an external director for an additional three-year term.

# B. Compensation

The
aggregate remuneration we paid for the year ended December 31, 2006 to all executive
officers as a group (4 persons) was approximately $546,000 in salaries, fees, commissions
and bonuses. This amount includes approximately $67,000 set aside to provide for pension,
retirement or similar benefits provided to our directors and executive officers.

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Members
of our board of directors, other than our external directors, do not receive cash
compensation for their service on the board of directors or any committee of the board of
directors. However, all of our directors are reimbursed for their expenses for each board
of directors meeting attended. Our external directors received an aggregate of
approximately $11,900 for the year ended December 31, 2006.

At
the meeting of our shareholders held on March 1, 2004, a special majority of our
shareholders who voted at that meeting, approved the grant of an option to purchase 72,000
of our Ordinary Shares to each of our nine directors serving on our Board of Directors at
the time, with the exception of Aviv Tzidon, the Chairman of our Board of Directors. The
options vested with the following Directors upon their completion of one full year of
service on our board following the March 1, 2004 shareholders meeting: Yaron Sheinman
(formerly, a member of our board of directors), Avi Leumi, Uri Manor, Eric Chan, Gadi
Aviram, Rimon Ben-Shaoul, Orit Stav and Amnon Harari and are exercisable at a price of
$0.18 per share for a period of three years.

At
the meeting of our shareholders held on March 1, 2004, a majority of our shareholders who
voted at that meeting also approved the grant of an option to purchase 9,000,000 of our
Ordinary Shares to Mr. Aviv Tzidon. One fifth of the options will vest upon the completion
of each full year of service on our board, which commenced on November 24, 2003, for a
period of five years and will be exercisable at a price of $0.18 per share for a period of
three years.

Taking
into account the option grants described in the preceding two paragraphs above, as of
March 31, 2007, options to purchase 11,226,000 Ordinary Shares granted to our directors
and executive officers under our option plans were outstanding. The exercise price of
these options was $0.18 per share. Of these options, options to purchase 7,086,000
Ordinary Shares are currently exercisable or will become exercisable within 60 days of
such date.

# C. Board Practices

Our
articles of association provide for a board of directors of not less than two and no more
than fifteen members. Each director is elected to serve until the next annual general
meeting of shareholders and until his or her successor has been elected. Officers serve at
the discretion of the board of directors. The Israeli Companies Law, which entered into
effect on February 1, 2000 and was amended most recently in March 2005 requires that, at
least one external director have financial and accounting expertise and the other external
directors are to possess professional qualifications as promulgated by regulations to the
Companies Law; these regulations provide that financial and accounting expertise require
such external director to possess a high level of understanding in business matters, such
that he or she can read and understand financial statements in depth and be able to raise
issues with respect to the manner in which the financial data is presented therein. The
companys board of directors is to determine such candidates qualifications
based on his or her education, experience and skills regarding financial and control
matters in companies of similar size and in a similar industry and knowledge of
preparation and approval of financial statements under the Companies Law and Israeli
securities laws.

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Our
articles of association provide that any director may, by written notice, appoint another
person to serve as a substitute director and may cancel such appointment. According to the
Companies Law, a person may not serve as a substitute director for more than one director
and a director may not serve as a substitute director. Any substitute director will have
all of the rights and obligations of the director appointing him or her, except the power
to appoint a substitute, unless the instrument appointing him provides otherwise, and the
right to remuneration. Appointment of a substitute director for a member of a committee of
the board of directors is only permitted if the substitute is a member of the board of
directors and does not regularly serve as a member of such committee. If the committee
member being substituted is an external director, such substitute may only be another
external director possessing the same expertise as the external director being substituted
and may not be a regular member of such committee. Unless the time period or scope of any
appointment is limited by the appointing director, the appointment is effective for all
purposes, but will expire upon the expiration of the appointing directors term. To
our knowledge, no director currently has appointed any other person as a substitute
director.

# External Directors

Under
the Companies Law, companies incorporated under the laws of Israel whose shares have been
offered to the public in or outside of Israel are required to appoint no less than two
external directors. The Companies Law provides that a person may not be appointed as an
external director if the person or the persons relative, partner, employer or any
entity under the persons control, has, as of the date of the persons
appointment to serve as external director, or had, during the two years preceding that
date, any affiliation with the company, any entity controlling the company or any entity
controlled by the company or by this controlling entity. The term affiliation includes:

| |  | an
employment relationship;
| | - | ---------------------------

| |  | a
business or professional relationship maintained on a regular basis;
| | - | ----------------------------------------------------------------------

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

| |  | service
as an office holder.
| | - | ----------------------------

48

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No
person can serve as an external director if the persons position or other business
creates, or may create, conflict of interests with the persons responsibilities as
an external director. A person shall be qualified to serve as an external director only if
he or she possesses accounting and financial expertise or professional qualifications. At
least one external director must posses accounting and financial expertise and the other
external directors are to possess professional qualifications as promulgated by
regulations to the Companies Law; these regulations provide that financial and accounting
expertise require such external director to possess a high level of understanding in
business matters, such that he or she can read and understand financial statements in
depth and be able to raise issues with respect to the manner in which the financial data
is presented therein. The companys board of directors is to determine such
candidates qualifications based on his or her education, experience and skills
regarding financial and control matters in companies of similar size and in a similar
industry and knowledge of preparation and approval of financial statements under the
Companies Law and Israeli securities laws. These requirements do not apply to external
directors appointed before the recent amendment to the Companies Law but will apply to
their reappointment for an additional term. Until the lapse of two years from termination
of office, a company may not engage an external director to serve as an office holder and
cannot employ or receive services from that person, either directly or indirectly,
including through a corporation controlled by that person. External directors are to be
elected by a majority vote at a shareholders meeting, provided that either:

| |  | the
total number of votes for the appointment of the external directors shall include the
votes of at least one third of the shares represented at the meeting in person or by
proxy, which are not held by controlling shareholders of the company; or
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of votes against the appointment of the external directors, among the
non-controlling shareholders of the company, shall not exceed 1% of the aggregate voting
rights in the company.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

When
counting the votes of the non-controlling shareholders, abstentions are not to be included
in such calculations.

An
external director is entitled to compensation as provided in regulations promulgated under
the Companies Law and is otherwise prohibited from receiving any compensation, directly or
indirectly, in connection with services provided as an external director. We compensate
our two external directors in accordance with regulations promulgated under the Companies
Law.

The
initial term of an external director is three years and may be extended for an additional
three years. Each committee of a companys board of directors, which exercises board
powers, is required to include at least one external director. However, the audit
committee should include all the external directors.

Pursuant
to the decisions of the Special General Meetings dated July 9, 2002 and March 1, 2004,
respectively, Amnon Harari and Orit Stav were each appointed as external directors of the
Company for a three-year term. On June 28, 2005, our shareholders extended Mr.
Hararis appointment to continue to serve as an external director for an additional
three-year term.

49

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# Exculpation, Insurance
and Indemnification of Directors and Officers

Under
the Companies Law, an Israeli company may not exempt an office holder from liability with
respect to a breach of his duty of loyalty, but may exempt 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, provided, that the company is so permitted under its articles of
association. The breach of such duty is governed by Israeli contract laws.

Office Holder Insurance

Our
articles of association provide that, subject to the provisions of the law, we may enter
into a contract for the insurance of the liability of any of our office holders with
respect to:

| |  | a
breach of his duty of care to us or to another person;
| | - | --------------------------------------------------------

| |  | a
breach of his duty of loyalty to us, provided that the office holder acted in good faith
and had reasonable cause to assume that his act would not prejudice our interests; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
financial liability imposed upon him in favor of another person concerning an act
performed by him in his capacity as an office holder.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

Indemnification of Office
Holders

Our
articles of association provide that we may indemnify an office holder against:

| |  | a
financial liability imposed on him in favor of another person by any judgment, including
a settlement or an arbitrators award approved by a court concerning an act
performed in his capacity as an office holder; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reasonable
litigation expenses, including attorneys fees, expended by the office holder or
charged to him by a court, in proceedings we institute against him or instituted on our
behalf or by another person, or in a criminal charge from which he was acquitted, or a
criminal charge in which he was convicted for a criminal offense that does not require
proof of intent, in each case relating to an act performed in his capacity as an office
holder.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
the Companies Law, these provisions are subject to shareholder approval.

50

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Limitations on Insurance
and Indemnification

The
Companies Law provides that a company may not indemnify an office holder nor enter into an
insurance contract which would provide coverage for any monetary liability incurred as a
result of any of the following:

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

| |  | a
breach by the office holder of his duty of care if the breach was done intentionally or
recklessly;
| | - | -----------------------------------------------------------------------------------------------------

| |  | any
act or omission done with the intent to derive an illegal personal benefit; or
| | - | ----------------------------------------------------------------------------------

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

In
addition, under the 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, in specified circumstances, by our shareholders.

We
have obtained directors and officers liability insurance.

# Audit Committee

Under
the Companies Law, the board of directors of any public company, as defined by the
Companies Law, must appoint an audit committee comprised of at least three directors,
including all of the external directors, but excluding the chairman of the board of
directors, the general manager, the chief executive officer and a controlling shareholder
or its relative and any director employed by the company or who provides services to the
company on a regular basis. Ken Lalo (appointed following the resignation of Yaron
Sheinman), Amnon Harari and Orit Stav currently serve as members of our Audit Committee.
Orit Stav is the financial expert of the Committee.

The
role of the audit committee is to examine flaws in the companys business management,
in consultation with its internal auditor and independent accountants, and suggest
appropriate courses of action.

In
addition, the approval of the audit committee is required to effect specified actions and
transactions with office holders and interested parties. An interested party is defined in
the Companies Law as a 5% or greater shareholder, any person or entity who has the right
to designate one or more directors or the general manager of the company or any person who
serves as a director or as a general manager. An audit committee may not approve an action
or a transaction with an interested party or with an office holder unless at the time of
approval the two external directors are serving as members of the audit committee and at
least one external director was present at the meeting in which such approval was granted.

51

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# Management Employment
Agreements

We
have entered into employment or consulting agreements with each of our executive officers.
These agreements contain various provisions, including provisions relating to assignment
of intellectual property rights to us and confidentiality and are in effect until
terminated by either party upon advance notice or otherwise in accordance with the terms
of the particular agreement. All of these agreements also contain non-competition
provisions. Under the Companies Law, in a public company, as defined in the Companies Law,
the chief executive officer may not serve as the companys chairman of the board.
However, the shareholders of the company may approve the service of the chairman of the
board also as the chief executive officer, for periods of up to three years each,
provided, that at least two-thirds of the votes of non-controlling shareholders present
and voting at the meeting vote affirmatively.

# Employee Share Option
Plans

We
have two employee share option plans. Options granted under our option plans generally
vest over a period of two to five years. Options granted under each plan expire five or
eight years from the date of grant. Our share option plans are administered by our Board
of Directors. All of our employees are eligible to participate in our option plans. Our
board of directors has complete discretion to make all decisions relating to the
interpretation and operation of our option plans, including the discretion to determine
which eligible individuals are to receive an award, and to determine the type, number,
vesting requirements and other features and conditions of each award.

On
January 4, 2004, our board of directors adopted a new share option plan under which
options for the purchase of 5,000,000 Ordinary Shares of the Company may be granted to our
employees and consultants. In 2006, our Board of Directors approved an increase to the
total option program to 5,200,000 Ordinary Shares. Under this plan, as of March 31, 2007,
4,960,000 options were granted to employees and consultants of the Company, at an exercise
price of $0.145  $0.65 each. These options will vest over five years with one-fifth
vesting each year, and each increment expiring three years after vesting. Moreover, as of
March 31, 2007, an additional 240,000 Ordinary Shares of the Company were reserved for
issuance pursuant to options issuable under this share option plan.

As
of March 31, 2007, we had outstanding options for the purchase of an aggregate of
4,966,000 Ordinary Shares of the Company.

52

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# Employees

The
following table sets forth for the last three fiscal years, the number of our employees
engaged in the specified activities:

|                                      | Year ended December 31,
|------------------------------------- | -----------------------
|
|
|
|
|Production & Research and Development |                        
|Marketing and Sales                   |                        
|Administration and Management         |                        
|                                      |                        
|Total                                 |                        
|                                      |                        

As
of, March 31, 2007, we employed approximately 68 employees in research and development
operations and productions, both internally financed and pursuant to contracts with our
customers performed an integral role in our various projects

Our
employees are required to sign a nondisclosure agreement covering all of our proprietary
information which they might possess or to which they might have access. We believe that
we have satisfactory labor relations with our employees and have never experienced a work
stoppage.

We
are subject to labor laws and regulations in Israel. We and our Israeli employees are also
subject to certain provisions of the general collective bargaining agreements between the
Histadrut, the General Federation of Labor in Israel, and the Coordination Bureau of
Economic Organizations, including the Industrialists Association, by order of the Israel
Ministry of Labor and Welfare. None of our employees are represented by a labor union and
we have not experienced any work stoppages. We generally provide our employees with
benefits and working conditions beyond the required minimums. In addition to salary and
other benefits, certain of our marketing and sales personnel are paid commissions based on
our performance in certain territories worldwide.

We
are subject, like all other Israeli employers, to Israeli labor laws and regulations. The
laws principally concern matters like paid annual vacation, paid sick days and other
conditions of employment. In addition, Israeli law generally requires severance pay, which
may be funded by managers insurance described below (or by other funds), upon the
retirement or death of an employee or termination of employment, subject to the provisions
of the law. Provisions for severance pay amount to approximately 8.33% of wages.
Furthermore, 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. These amounts also include payments by the employee for national health
insurance. The total payments to the National Insurance Institute are equal to
approximately 16.25% of the wages (up to a specified amount), of which the employee
contributes approximately 66% and the employer contributes approximately 34%.

53

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We
follow a practice, although not legally required, to contribute funds on behalf of all of
our employees to a fund known as managers insurance. This fund provides
a combination of savings plan, insurance and severance pay benefits to the employee,
giving the employee a lump-sum payment upon retirement and securing the severance pay, if
legally entitled, upon termination of employment. We decide whether each employee is
entitled to participate in the plan, and each employee who agrees to participate
contributes an amount equal to 5% of his or her basic salary and the employer contributes
approximately 14% of the salary.

# D. Share Ownership

As
of March 31, 2007, Aviv Tzidon beneficially owned an option to purchase 5,400,000 Ordinary
Shares, (for further information, see item 6B) exercisable at a price of $0.18 per share
for three years. Assuming the exercise of such options and no other exercise of our
convertible securities, Mr. Tzidon will hold 4.42% of our then outstanding Ordinary
Shares. In addition, Mr. Tzidon holds 33.3% of Chun LP, which beneficially owned, as of
March 31,2007, 58,142,608 Ordinary shares and a four-year option to purchase 10,864,444
Ordinary Shares, vesting immediately and exercisable at a price of $0.18 per share.
Assuming the exercise of such options and no other exercise of our convertible securities,
Chun will hold 54.03% of our then outstanding Ordinary Shares.

Other
than Mr. Aviv Tzidon, none of our directors and officers beneficially owned more than 1%
of our outstanding equity securities.

|ITEM 7. | Major
Shareholders and Related Party Transactions
|------- | -------------------------------------------------

# A. Major Shareholders

The
following table sets forth certain information regarding the beneficial ownership of our
Ordinary Shares as of, March 31, 2007, by each person or entity known to own beneficially
more than 5% of our outstanding Ordinary Shares based on information provided to us by the
holders or disclosed in public filings with the Securities and Exchange Commission.

54

---

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|Name                                   | Number of Ordinary
Shares Beneficially Owned(1) | Percentage of
Outstanding Ordinary
Shares(2)
|-------------------------------------- | ----------------------------------------------- | --------------------------------------------
|
|
|
|
|CHUN Holdings Limited Partnership (3)  |                                                 |                                             
|c/o Yigal Arnon & Co.                  |                                                 |                                             
|1 Azrieli Center Tel-Aviv 67021 Israel |                                                 |                                             
|                                       |                                                 |                                             
|H.S.N General Managers Holdings LP     |                                                 |                                             
|7 Berkowitz St.                        |                                                 |                                             
|Tel Aviv Israel                        |                                                 |                                             
|                                       |                                                 |                                             
|Polar Investments House                |                                                 |                                             
|Platinum House                         |                                                 |                                             
|21 Ha'arbah St.                        |                                                 |                                             
|Tel Aviv 64731 Israel                  |                                                 |                                             
|                                       |                                                 |                                             
|Bank Leumi Le-Israel B.M.              |                                                 |                                             
|24-32 Yehuda Halevi St.                |                                                 |                                             
|Tel Aviv 63432 Israel                  |                                                 |                                             

|(1) | Except
as otherwise noted and pursuant to applicable community property laws,
                    each person named in the table has sole voting and investment power
with respect                     to all ordinary shares listed as owned by such person.
Shares beneficially owned                     include shares that may be acquired
pursuant to options that are exercisable                     within 60 days of March 31,
2007.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Ordinary
shares deemed beneficially owned by virtue of the right of any person
                    or group to acquire these ordinary shares within 60 days of March 31,
2007 are                     treated as outstanding only for the purposes of determining
the percent owned by                     such person or group. The percentage of
outstanding ordinary shares is based on                     116,863,757 Ordinary Shares
outstanding as of March 31, 2007.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Based
on information reported by Chun LP in its Schedule 13D, the general
               partner of Chun LP is Chun Holdings Ltd., a private Israeli company
jointly held                by Aviv Tzidon (33.3%), Aeronautics Defense System Ltd.
(33.3%) and Prescient                System & Technologies Pte. Ltd. (33.3%).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes
three separate warrants for the purchase of 6,000,000 ordinary shares                per
each warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable
               for a period of three years, with a mandatory exercise mechanism under
certain                conditions.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
3,181,807 Ordinary Shares held by Koonras Technologies Ltd., a
                    wholly-owned subsidiary of Polar Investments Ltd. It also includes a
four-year                     warrant to purchase 2,158,960 (including 911,678 warrants
held by Koonras) of                     our Ordinary Shares at a price of $0.18 share,
exercisable immediately.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Includes a four-year warrant to purchase 10,864,444 of our Ordinary Shares at a
                    price of $0.18 share, exercisable immediately.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

As of March 31, 2007, there were a
total of five holders of record of our ordinary shares with addresses in the United
States. Such United States holders were, as of such date, the holders of record of
13,256,359 ordinary shares representing approximately 11.34% of our outstanding share
capital.

# B. Related Party
Transactions

# Agreement with Consult
Wise Pte Ltd.

On
January 1, 2004, we entered into an agreement with Consult Wise Pte Ltd., a Singaporean
company. Maayan Tzidon, the brother of Aviv Tzidon, the Chairman of our Board of
Directors, holds 50% of the issued and outstanding shares of Consult Wise. Pursuant to
this agreement, we agreed to pay Consult Wise $3,000 per month for the provision of its
marketing services of our products and services in Korea and Singapore, for a period of
three years commencing January 1, 2004. In lieu of cash, we agreed to pay the monthly fee
in our Ordinary Shares based on a per share price of $0.18. In order to facilitate the
payment of shares, a trustee was issued 600,000 of our Ordinary Shares and was instructed
to release 16,667 of our Ordinary Shares to Consult Wise each month during the term of the
agreement.

55

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On January 1, 2007, following the
expiration of the above agreement, we entered into a new agreement with Consult Wise Pte
Ltd. Pursuant to this agreement, we agreed to pay Consult Wise $3,500 per month for the
provision of its marketing services and $3,500 per month for supporting our operating
programs in Singapore, for a period of two years commencing January 1, 2007; furthermore,
Consult Wise is entitled to commissions on purchase orders issued by customers introduced
to us pursuant to its marketing services. For further information see:

| |  | Sale
of Shares and Issue of Warrants to Investors below.
| | - | ----------------------------------------------------------

| |  | Note
16 and note 20 to the Consolidated Financial Statements included in this annual report.
| | - | --------------------------------------------------------------------------------------------

| |  | Agreement
with Affiliate of Dekel Tzidon
| | - | ----------------------------------------

| |  | On
March 1, 2004, the Company entered into a consulting agreement with Eyepoint Ltd., an
Israeli company wholly owned by Mr. Dekel Tzidon, brother of Mr. Aviv Tzidon, the
Chairman of our Board of Directors. Pursuant to this consulting agreement, Mr. Tzidon
continues to serve as the Companys Vice President of Research & Development and
Chief Technological Officer. The terms of this agreement were approved by the Companys
Audit Committee in July 2004.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Sale of Shares to
Principal Shareholders

Sale of Shares to and Issue of
Warrants to H.S.N General Managers Holdings L.P.

In
March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership
led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the
issuance of 20,000,000 Ordinary Shares, representing approximately 17% of our issued share
capital, at a price per share of $0.18. In connection with this investment, HSN was issued
three separate warrants for the purchase of 6,000,000 of our Ordinary Shares per each
warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three
years, with a mandatory exercise mechanism under certain conditions. As of March 2006, Mr.
Dor serves as a member of our board of directors.

56

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Sale of Shares to and
Issue of Warrants to Chun

On
November 21, 2003, Chun Holdings Ltd., or Chun, issued a tender offer to purchase all of
our outstanding shares for a purchase price of $0.18 per share. Pursuant to the tender
offer, which expired on December 30, 2003, some of our shareholders, including Clal
Industries Ltd. and our former controlling shareholder Elisra Electronics Systems Ltd., or
Elisra, tendered an aggregate of 7,142,608 of their shares, constituting 67% of our issued
and outstanding share capital. Upon the request of Chun, all of the tendered shares were
registered in the name of its affiliate Chun Holdings L.P., or Chun LP which became our
controlling shareholder. As of, March 31, 2007 Chun was holding an aggregate of 49.75% of
our outstanding shares and 54.03 % including options that are exercisable within 60 days
of March 31, 2007.

Following
the expiration of the tender offer, Elisra no longer held any of our share capital.

On
March 3, 2004, Chun entered into an agreement to purchase 33,333,333 of our Ordinary
Shares at a price per share of $0.18 for an aggregate purchase price of $6,000,000. This
transaction was approved by our Audit Committee, Board of Directors and by a special
majority of our shareholders who did not have a personal interest in the transaction and
who voted at our Shareholders Meeting held on March 1, 2004.

Chun
also agreed on such date to provide our company with a credit line in the amount of $3.2
million. In consideration for this credit line our Audit Committee and our Board of
Directors agreed, subject to shareholder approval, to grant Chun a four-year warrant to
purchase an additional 40,000,000 of our Ordinary Shares for an exercise price of $0.18
per share. A special majority of our shareholders who did not have a personal interest in
the transaction and who voted at our shareholders meeting held on March 1, 2004, approved
the grant of the warrant. Chun, however, waived its right to receive warrants for the
purchase of 10,000,000 of our Ordinary Shares and agreed that such warrants be granted to
other investors as disclosed below. During the third quarter of 2004, the $3.2 million
credit line was replaced by an additional investment in the same amount made by Chun in
our share capital.

Options issued to the
Chairman of the Board of Directors

On
January 1, 2004, Aviv Tzidon received an option to purchase 9,000,000 of our Ordinary
Shares issued for services rendered as Chairman of our Board of Directors. One fifth of
the options will vest upon completion of each full year of service on our Board of
Directors, which commenced on November 24, 2003. Each option is exercisable for three
years following vesting and is exercisable at a price per share of $0.18. This transaction
was approved by our Audit Committee, our Board of Directors and a special majority of our
shareholders who did not have a personal interest in the transaction and who voted at our
shareholders meeting held on March 1, 2004.

57

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Sale of Shares and
Issuance of Warrants to Investors

On
March 3, 2004, a group of investors entered into an investment agreement to purchase
22,428,225 of our Ordinary Shares at a price per share of $0.18 for an aggregate purchase
price of $4,037,080. Two of the investors, Polar Communications Ltd. and Koonras
Technologies Ltd., who were also existing security holders of the Company prior to the
March 2004 investment, were issued additional shares in consideration for their agreement
to convert an aggregate debt owed to them of $100,000 into 555,556 of our Ordinary Shares
at a price per share of $0.18. Pursuant to this investment agreement, the investors were
also issued four-year warrants to purchase an aggregate of 10,000,000 of our Ordinary
Shares with an exercise price of $0.18 per share; Chun LP was initially granted these
warrants, but subsequently waived its rights to receive such warrants in favor of the
investors, pro rata to their investments. This transaction was approved by our Audit
Committee, our Board of Directors and a special majority of our shareholders who did not
have a personal interest in the transaction and who voted at our Shareholders Meeting held
on March 1, 2004.

Convertible Loan
Agreements

On
March 3, 2004, three of our banks, namely Bank Leumi Le-Israel B.M., Bank Hapoalim B.M.
and the Industrial Development Bank Ltd., agreed to convert existing loans in the amount
of $1.1 million, $700,000 and $200,000, respectively, into 6,111,111; 3,888,889; and
1,111,111 of our Ordinary Shares, respectively.

# Employment Agreements

We
have entered into employment agreements with each of our executive officers. See
Item 6  Directors, Senior Management and Employees  C. Board
PracticesManagement Employment Agreements.

# C. Interests of Experts
and Counsel

Not
applicable.

|ITEM 8. | Financial
Information
|------- | ---------------------

# A. Consolidated
Statements and Other Financial Information

The
Financial Statements required by this item are found at the end of this Annual Report,
beginning on page F-1.

# Legal Proceedings

We
are not a party to any material legal proceedings.

58

---

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# B. Significant Changes

There
have been no material changes in our financial position since December 31, 2006; see Item
4  Information on the Company  A. History and Development of the Company.

|ITEM 9. | The
Offer and Listing
|------- | ---------------------

# A. Offer and Listing
Details

Our
Ordinary Shares have traded on the Over The Counter Bulletin Board under the symbol
BVRSF.OB since February 2003 and previously traded on the Nasdaq Small Cap Market from
March 2001. From October 1998 until March 2001 our shares were traded on the Nasdaq
National Market.

The
following table sets forth, for the periods indicated, the range of high and low sales
prices of our Ordinary Shares:

|                              | High | Low
|----------------------------- | ---- | ---
|
|
|
|
|2002                          |      |    
|Year ending December 31, 2002 |      |    
|                              |      |    
|2003                          |      |    
|Year ending December 31, 2003 |      |    
|                              |      |    
|2004                          |      |    
|Year ending December 31, 2004 |      |    
|                              |      |    
|2005                          |      |    
|First Quarter                 |      |    
|Second Quarter                |      |    
|Third Quarter                 |      |    
|Fourth Quarter                |      |    
|                              |      |    
|2006                          |      |    
|First Quarter                 |      |    
|Second Quarter                |      |    
|Third Quarter                 |      |    
|Fourth Quarter                |      |    
|October                       |      |    
|November                      |      |    
|December                      |      |    
|                              |      |    
|2007                          |      |    
|January                       |      |    
|February                      |      |    
|March                         |      |    

59

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# B. Plan of Distribution

Not
applicable.

# C. Markets

Our
Ordinary Shares traded on the Nasdaq Capital Market until February 13, 2003. Our Ordinary
Shares were delisted from the Nasdaq Capital Market after we failed to comply with its
required listing standards. Since February 14, 2003, our Ordinary Shares have been traded
on the Over-the-Counter Bulletin Board under the symbol BVRSF.OB.

# D. Selling Shareholders

Not
applicable.

# E. Dilution

Not
applicable.

# F. Expenses of the Issue

Not
applicable.

|ITEM 10. | Additional
Information
|-------- | ----------------------

# A. Share Capital

Not
applicable.

# B. Memorandum and
Articles of Association

# Objects and Purposes

We
were first registered under Israeli law on January 6, 1998. Our registration number with
the Israel Registrar of Companies is 52-004362-1. Our objectives and purposes include the
development, design, manufacture and marketing of advanced training systems for military
objectives and a wide variety of other business purposes.

# Transactions Requiring
Special Approval

An
office holder is defined in the Companies Law as a director, general manager,
chief business manager, deputy general manager, vice general manager and any person
assuming the responsibilities of any of the foregoing positions without regard to such
persons title and any other manager who is directly subject to the general manager.

60

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The
Companies Law imposes a duty of care and a duty of loyalty on all office holders of a
company. The duty of care requires an office holder to act with the level of care which a
reasonable office holder in the same position would have acted under the same
circumstances. The breach of such duty is governed by Israeli contract laws. The duty of
care includes a duty to use reasonable means to obtain:

| |  | information
on the appropriateness of a given action brought for his approval or performed by him by
virtue of                            his position; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | all
other important information pertaining to the previous actions.
| | - | -------------------------------------------------------------------

The
duty of loyalty requires an office holder to act in good faith for the interests of the
company and includes a duty to:

| |  | refrain
from any conflict of interest between the performance of his duties in the company and
his personal                            affairs;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | refrain
from any activity that is competitive with the company;
| | - | ---------------------------------------------------------------

| |  | refrain
from exploiting any business opportunity of the company to receive a personal gain for
himself or                            others; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | disclose
to the company any information or documents relating to a companys affairs which
the office holder has received due to his position as an office holder.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

Each
person listed in the table under Item 6  Directors, Senior Management and
Employees  A. Directors and Senior Management is an office holder.

The
Companies Law requires that an office holder disclose to the company any personal interest
that he or she may have, and all related material information known to him or her, in
connection with any existing or proposed transaction by the company. The disclosure is
required to be made promptly and in any event, no later than the board of directors
meeting in which the transaction is first discussed. A personal interest of an office
holder includes an interest of a company in which the office holder is, directly or
indirectly, 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. If the transaction
is an extraordinary transaction, the office holder must also disclose any personal
interest held by his or her relative.

Under
the Companies Law, an extraordinary transaction is a transaction:

| |  | not
in the ordinary course of business;
| | - | ---------------------------------------

| |  | not
on market terms; or
| | - | -----------------------

| |  | likely
to have a material impact on the company's profitability, assets or liabilities.
| | - | ---------------------------------------------------------------------------------------

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Under
the Companies Law, once an office holder complies with the above disclosure requirement,
the board of directors may approve the transaction, unless the companys articles of
association provide otherwise. A transaction that is adverse to the companys
interest may not be approved. If the transaction is an extraordinary transaction, then it
also must be approved by the audit committee, before the board approval, and under certain
circumstances, by the shareholders of the company. A director 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 at this meeting or vote on this matter. If a majority of the
directors has a personal interest in a transaction, these directors are permitted to be
present and vote, but shareholder approval is also required.

Under
the Companies Law, the disclosure requirements which apply to an office holder also apply
to a controlling shareholder of a public company. A controlling shareholder includes a
shareholder that holds 25% or more of the voting rights in a public company if no other
shareholder owns more than 50% of the voting rights in the company. Extraordinary
transactions of a public company with a controlling shareholder or in which a controlling
shareholder has a personal interest, and the terms of compensation of a controlling
shareholder who is an office holder, require the approval of the audit committee, the
board of directors and the shareholders of the company. The shareholder approval must
satisfy either of the following criteria:

| |  | the
majority of the votes for the approval includes the votes of at least one-third of the
total votes of shareholders who are present at the meeting and who have no personal
interest in the transaction; the votes of abstaining shareholders shall not be included
in the number of the said total votes; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of votes against the approval, among the shareholders who are present at the
meeting and who have no personal interest in the transaction shall not exceed 1% of the
aggregate voting rights in the company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For
information concerning the direct and indirect personal interests of certain of our office
holders and principal shareholders in certain transactions with us, see Item 7
 Major Shareholders and Related Party Transactions  B. Related Party
Transactions.

# Directors
Compensation

Under
the Companies Law, all arrangements as to compensation of office holders who are not
directors require approval of the board of directors. Arrangements as to compensation of
directors also require audit committee approval, before board approval, and shareholder
approval. Nevertheless, pursuant to our articles of association, our directors who are not
our employees or professional services providers shall not be paid any remuneration for
their services unless it was approved by the general meeting of our shareholders.

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# Directors Borrowing
Powers

Our
board of directors may from time to time, in its discretion, cause the Company to borrow
or secure the payment of any sum or sums of money for the purposes of the Company. Such
borrowing powers may be exercised by a majority of the board in accordance with our
articles of association.

# Rights attached to our
Shares

Dividend
Rights. Our articles of association provide that our shareholders at a general meeting
and upon the recommendation of our board of directors may from time to time, declare such
dividend as may appear to be justified but not in excess of our board of directors
recommendation. Subject to the rights of the holders of shares with preferential or other
special rights that may be authorized in the future, holders of Ordinary Shares are
entitled to receive dividends according to their rights and interest in our profits.

Voting
Rights. Holders of Ordinary Shares have one vote for each ordinary share held on all
matters submitted to a vote of shareholders. These voting rights may be affected by the
grant of any special voting rights to the holders of a class of shares with preferential
rights that may be authorized in the future. The Ordinary Shares do not have cumulative
voting rights in the election of directors. As a result, holders of Ordinary Shares that
represent more than 50% of the voting power have the power to elect all the directors to
the exclusion of the remaining shareholders.

Liquidation
Rights. 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 their respective holdings. This liquidation right may be affected by the grant of
preferential dividends or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

Redemption
Provisions. We may, subject to applicable law, issue redeemable preference shares and
redeem the same.

Capital
Calls. Under our memorandum of association and the Companies Law, the liability of our
shareholders is limited to the par value of the shares held by them.

Preemptive,
First Refusal and Co-Sale Rights. All outstanding Ordinary Shares are validly issued,
fully paid and non-assessable and do not have preemptive rights, rights of first refusal
or co-sale rights.

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Transfer
of Shares. Fully paid Ordinary Shares are issued in registered form and may be
transferred pursuant to our articles of association, unless such transfer is restricted or
prohibited by another instrument and subject to applicable securities laws.

# Modification of Rights

Unless
otherwise provided by our articles of association, rights attached to any class may be
modified or abrogated by a resolution adopted in a general meeting approved by a majority
of 75% of the voting power represented at the meeting in person or by proxy and voting
thereon, subject to the sanction of a resolution passed by majority of the holders of 75%
a majority of the shares of such class present and voting as a separate general meeting of
the holders of such class.

# Shareholders
Meetings and Resolutions

The
quorum required for an ordinary meeting of shareholders consists of at least two
shareholders present in person or by proxy, who hold or represent between them at least
33-1/3% of the outstanding voting shares, unless otherwise required by applicable rules. 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 chairman of the
board may designate. At such reconvened meeting the required quorum consists of any two
shareholders present in person or by proxy.

Under
the Companies Law, each shareholder of record will be provided at least 21 calendar
days prior notice of any general shareholders meeting.

Under
the Companies Law and our articles of association, all resolutions of our shareholders
require a simple majority of the shares present, in person or by proxy, and voting on the
matter, subject to certain exceptions provided for under the Companies Law, which require
a majority of at least 75% of the shares present. However, the Companies Law requires that
any amendment to the articles of association of a company incorporated prior to February
1, 2000, shall be approved by holders of at least 75% of the voting rights represented at
the meeting, in person or by proxy, and voting thereon, unless the articles are amended to
the effect of requiring a different majority.

Under
the Companies Law, each and every shareholder has a duty to act in good faith in
exercising his rights and fulfilling his obligations towards us and other shareholders,
such as in voting in the general meeting of shareholders on the following matters:

| |  | any
amendment to the articles of association;
| | - | ---------------------------------------------

| |  | an
increase of our authorized share capital;
| | - | --------------------------------------------

| |  | a
merger; or
| | - | ------------

| |  | approval
of certain actions and transactions that require shareholder approval.
| | - | -------------------------------------------------------------------------------

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In
addition, each and every shareholder has the general duty to refrain from depriving other
shareholders of their rights.

Our
annual general meetings are held once in every calendar year at such time (within a period
of not more than fifteen months after the last preceding annual general meeting) and at
such place determined by our board. All general meetings other than annual general
meetings shall be called extraordinary general meetings. Our board may, whenever it thinks
fit, convene an extraordinary general meeting at such time and place as it determines, and
shall be obligated to do so upon a requisition in writing in accordance with the Companies
Law.

# Limitation on Owning
Securities

The
ownership of our Ordinary Shares by nonresidents of Israel is not restricted in any way by
our memorandum of association and articles of association or the laws of the State of
Israel, except for citizens of countries, which are in a state of war with Israel, who may
not be recognized as owners of our Ordinary Shares.

# Mergers and Acquisitions
under Israeli Law

The
Companies Law includes provisions that allow a merger transaction and requires that each
company that is a party to a merger have the transaction approved by its board of
directors and a vote of at least 75% of its shares, at a shareholders meeting called
on at least 21 days prior notice. For purposes of the shareholders vote, unless a
court rules otherwise, the merger will not be deemed approved if a majority of the shares
held by parties other than the other party to the merger, or by any person who holds 25%
or more of the shares of the other party, or the right to appoint 25% or more of the
directors of the other party, vote against the merger. Upon the request of a creditor of
either party of the proposed merger, the court may delay or prevent the merger if it
concludes that there exists a reasonable concern that as a result of the merger, the
surviving company will be unable to satisfy the obligations of any of the parties to the
merger. In addition, a merger may not be completed unless at least 50 days have passed
from the time that a proposal for the approval of the merger has been filed with the
Israel Registrar of Companies and 30 days have passed from the time that the approval of
the merging parties shareholders has been received.

The
Companies Law also provides that an acquisition of shares of 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% shareholder of the company and there is no existing 25% or greater shareholder in the
company. If there is no existing 45% or greater shareholder in the company, the Companies
Law provides that an acquisition of shares of a public company must be made by means of a
tender offer if as a result of the acquisition the purchaser would become a 45%
shareholder of the company. Regulations adopted under the Companies Law provide that these
tender offer requirements do not apply to companies whose shares are listed for trading
outside of Israel if, according to the laws of the country in which the shares have been
offered to the public or in which the shares are listed for trading on an exchange,
including the rules and regulations of such exchange, there is either a restriction upon
any acquisition of control to any extent, or the acquisition of control to any extent
requires the purchaser to make a tender offer to the public.

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If
following any acquisition of shares, the acquirer will hold 90% or more of the
companys shares or of a class of shares, the acquisition may not be made other than
through a tender offer to acquire all of the shares of such class. If the shareholders who
declined the tender offer hold 5% or less of the companys outstanding share capital
or class of shares, all the shares that the acquirer offered to purchase will be
transferred to it. However, the tendered shareholders may seek to alter the consideration
by court order.

# C. Material Contracts

In
September 2001, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer
and producer of modern military training aircraft in Europe, for the supply of a MB339
training aircraft full mission simulator and three years of logistical support. The
contract price is $7.1 million, which, as in substantially all of our contracts, is
payable in accordance and subject to timely achievement of specific milestones during the
lifetime of the project. We completed this project during the second quarter of 2003 and
enter into the logistical support period. As of March 31, 2006, we received $0.1 million
under this contract.

In
April 2003, we entered into a contract with the air force of a Latin American country for
the development and supply of an F-16 training facility. The contract price is
approximately $5.0 million, which, as in substantially all of our contracts, is payable in
accordance and subject to timely achievement of specific milestones during the lifetime of
the project. We completed this project during the third quarter of 2005.

In
October 2003, we entered into a contract with the armed forces of a Latin American country
for the development and supply of a tank training center. The contract price is
approximately $2.7 million, which, as in substantially all of our contracts, is payable in
accordance with and subject to timely achievement of specific milestones during the
lifetime of the project. We completed this project during the fourth quarter of 2005.

In
November 2003, we entered into a contract, together with a European company, with the navy
of a European country for the development and supply of a naval tactical trainer. The
contract price is approximately $1.5 million (a significant portion of which will be
payable to us), which, as in substantially all of our contracts, is payable in accordance
with and subject to timely achievement of specific milestones during the lifetime of the
project. We completed this project during the first quarter of 2005.

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In
December 2003, we entered into a leasing contract with the Israel Air Force for the use
and maintenance of an ACMI system. The contract price is approximately $0.7 million, and
is payable on a monthly basis. We completed this contract during the third quarter of
2005.

In
July 2004, we entered into a follow on contract with a customer in Asia for the provision
of integrated logistic support services for a period of three years for a training system
that was previously provided by us. The contract price is approximately $1.6 million. We
expect to complete this project during the first quarter of 2007. As of March 31, 2007, we
received $1.4 million under this contract.

In
August 2004, we entered into a contract with a NATO Member for the provision of EHUD
Air Combat Maneuvering Instrumentation (ACMI) systems. The contract price is approximately
$6.0 million, which, as in substantially all of our contracts, is payable in accordance
and subject to timely achievement of specific milestones during the lifetime of the
project. We completed this project during the fourth quarter of 2005.

In
October 2004, we entered into a contract with Boeing for the integration of EHUD
ACMI systems on Boeings new F-15K aircraft, to be supplied to the Republic of Korea
Air Force. The contract price is approximately $1.5 million, which, as in substantially
all of our contracts, is payable in accordance and subject to timely achievement of
specific milestones during the lifetime of the project. We completed this project during
the fourth quarter of 2006.

In
November 2004, we entered into a contract with Systex Corporation, a leading Asian system
integration company for the supply of an infantry multi-weapon firing simulation system.
The contract price is approximately $2.6 million, which, as in substantially all of our
contracts, is payable in accordance and subject to timely achievement of specific
milestones during the lifetime of the project. We expect to complete this project during
the fourth quarter of 2007. As of March 31, 2007, we received $1.1 million under this
contract.

In
January 2005, we entered into an additional contract with Systex Corporation for the
supply of a tank simulation system. The contract price is approximately $1.4 million,
which, as in substantially all of our contracts, is payable in accordance and subject to
timely achievement of specific milestones during the lifetime of the project. We completed
this project during the fourth quarter of 2006.

In
September 2005, we entered into a contract with Elbit Systems for the supply of work-share
in a new F-16I simulator for the Israel Air Force. The contract price is approximately
$2.2 million, which, as in substantially all of our contracts, is payable in accordance
and subject to timely achievement of specific milestones during the lifetime of the
project. We expect to complete this project during the first quarter of 2008. As of March
31, 2007, we received $2.0 million under this contract.

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In
January 2006, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer
and producer of modern military training aircraft in Europe, for the upgrade of two MB339a
training aircraft simulators. The contract price is approximately $4.5 million, which, as
in substantially all of our contracts, is payable in accordance and subject to timely
achievement of specific milestones during the lifetime of the project. We expect to
complete this project during the third quarter of 2007. As of March 31, 2007, we received
$2.2 million under this contract.

In
March 2006, we entered into a contract with an international customer for the provision of
an F-16 MLU Improved Unit Line Trainer.  The contract price is $2.7 million,
which, as in substantially all of our contracts, is payable in accordance and subject to
timely milestones during the lifetime of the project.  We expect to complete this
project during the first quarter of 2008. As of March 31, 2007, we received $1.8 million
under this contract.

In
May 2006, we entered into an agreement with a leading European company for the provision
of In-Flight Electronic Warfare Simulator (IFEWS). The contract price is approximately
$1.7 million, which, as in substantially all of our contracts, is payable in accordance
and subject to timely achievement of specific milestones during the lifetime of the
project. We expect to complete this project during the second quarter of 2007. As of March
31, 2007, we received $1.2 million under this contract.

In
September 2006, we entered into a major contract with an international customer for the
supply of a distributed naval embedded training system.  The contract price is $11.9
million, which, as in substantially all of our contracts, is payable in accordance and
subject to timely milestones during the lifetime of the project.  We expect to
complete this project during the fourth quarter of 2010. As of March 31, 2007, we received
$3.0 million under this contract.

In
December 2006, we entered into an agreement with a European customer, for the Embedded
Virtual Avionics (EVA) solution. The contract price is approximately $1.2 million, which,
as in substantially all of our contracts, is payable in accordance and subject to timely
achievement of specific milestones during the lifetime of the project. We expect to
complete this project during the first quarter of 2007. As of March 31, 2007, we received
$1.0 million under this contract.

In
January 2007, we entered into Licenses agreement with an aircraft manufacturer, for the
Embedded Virtual Avionics (EVA) patent. As of March 31, 2007, BVR expected to receive
approximately $0.5 million, which is payable by two equal installments. As of March 31,
2007, we received $0.1 million under this agreement.

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In
March 2007, we entered into a three years maintenance contract for a naval embedded
training system supplied by BVR to an international customer. The contract price is
approximately $1.0 million, which is payable in accordance to timely milestones during the
lifetime of the project. We expect to complete this project during the first quarter of
2010.

In
March 2007, we entered into an agreement with a European customer, for the Embedded
Virtual Avionics (EVA) solution for a leading jet trainer. The contract price is
approximately $1.0 million, which, as in substantially all of our contracts, is payable in
accordance and subject to timely achievement of specific milestones during the lifetime of
the project. We expect to complete this project during the first quarter of 2008.

For
a summary of our other material contracts, see:

| |  | "Item
4 - Information on the Company - A. History and Development of the Company," including a
description of                            the Share Purchase Agreement entered into in
March 2006 with H.S.N General Managers Holdings                            L.P., an
Israeli limited partnership led by Mr. Nir Dor.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Item
4  Information on the Company  B. Business Overview Strategic
Relationships, including a description of the Cooperation Agreement entered into
with MLM in August 2005.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | "Item
6 - Directors, Senior Management and Employees - B. Compensation"
| | - | -----------------------------------------------------------------------

| |  | "Item
7 - Major Shareholders and Related Party Transactions - B. Related Party Transactions."
| | - | ---------------------------------------------------------------------------------------------

# D. Exchange Controls

Under
current Israeli regulations, we may pay dividends or other distributions in respect of our
Ordinary Shares either in non-Israeli or Israeli currencies. If we make these payments in
Israeli currency, they will be freely converted into non-Israeli currencies at the rate of
exchange prevailing at the time of conversion. Because exchange rates between the NIS and
the dollar continuously fluctuate, a U.S. shareholder will be subject to the risk of
currency fluctuations between the date when we declare NIS-denominated dividends and the
date when we pay them in NIS. See Item 3. Key
Information D. Risk Factors.

Non-residents
of Israel may freely hold and trade our securities pursuant to the general permit issued
under the Israeli Currency Control Law, 1978. Neither our memorandum of association nor
the laws of the State of Israel restrict in any way the ownership of our Ordinary Shares
by non-residents, except that these restrictions may exist with respect to citizens of
countries which are in a state of war with Israel.

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# E. Taxation

# Israeli Tax
Considerations and Government Programs

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
certain Israeli and United States tax consequences to purchasers of our Ordinary Shares
and certain Israeli Government programs benefiting us. To the extent that the discussion
is based on new tax legislation that has not been subject to judicial or administrative
interpretation, there can be no assurance that the views expressed in the discussion will
be accepted by the tax authorities in question. The discussion is not intended, and should
not be construed, as legal or professional tax advice and is not exhaustive of 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.

General Corporate Tax
Structure

Israeli
companies are subject to corporate tax at the rate of 29% of taxable income. Under current
law, the corporate tax rates are scheduled to be reduced to 28% in January 2008, and are
expected to be further reduced to 26% in 2009 and 25% in 2010 and thereafter. However, the
effective tax rate payable by a company which derives income from an Approved Enterprise
(as further discussed below) may be considerably less.

Tax Benefits under the Law for the
Encouragement of Capital Investments, 1959

On
March 30, 2005, the Knesset approved a reform of the Encouragement of Capital Investments
Law  1959 (the Encouragement Reform).

Following
in Section A is the outline of The Investment Law before the Encouragement Reform. Section
B notes several of the significant changes in the Investment Law which are relevant to our
company.

The
Investment Law provides that terms and benefits included in any certificate of approval
that was granted before the Encouragement Reform came into effect will remain subject to
the provisions of the Investment Law as they were on the date of such approval. Therefore
the Encouragement Reform will not apply to any of our programs approved under the
Investment Law before the Encouragement Reform.

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# A. The Investment Law
before the Encouragement Reform

The
Investment Law provides that a proposed capital investment in eligible facilities may,
upon application to the Investment Center of the Ministry of Industry and Commerce of the
State of Israel, be designated as an Approved Enterprise. Each certificate of
approval for an Approved Enterprise relates to a specific investment program delineated
both by its financial scope, including its capital sources, and by its physical
characteristics, e.g., the equipment to be purchased and utilized pursuant to the program.
The tax benefits derived from any such certificate of approval relate only to taxable
income attributable to the specific Approved Enterprise. If a company has more than one
approval or only a portion of its capital investments are approved, its effective tax rate
is the result of a weighted combination of the applicable rates. The tax benefits under
the law are not generally available with respect to income derived from products
manufactured outside of Israel.

Taxable
income of a company derived from an Approved Enterprise is subject to corporate tax at a
maximum rate of 25% (rather than the ordinary corporate tax rate) for the benefit
period. The benefit period is seven years (and under certain
circumstances, as further detailed below, ten years) commencing with the year in which the
Approved Enterprise first generates taxable income, and is limited to twelve years from
commencement of production or 14 years from the date of approval, whichever is earlier.
The Investment Law also provides that a company that has an Approved Enterprise is
entitled to accelerated depreciation on its property and equipment that are included in an
approved investment program.

A
company owning an Approved Enterprise may elect to receive an alternative package of
benefits. Under the alternative package of benefits, a companys undistributed
income derived from an Approved Enterprise will be exempt from corporate tax for a period
of between two and ten years from the first year of taxable income, depending on the
geographic location of the Approved Enterprise within Israel, and such company will be
eligible for a reduced tax rate for the remainder of the benefits period.

Our
requests for designation of our capital investment at our facility in Rosh Haayin as
an Approved Enterprise program were approved under the Investment Law. For
this Approved Enterprise, we elected the alternative package of benefits.

A
company that has elected the alternative package of benefits and that subsequently pays a
dividend out of income derived from the Approved Enterprise during the tax exemption
period will be subject to tax in respect of the amount distributed (including the tax
thereon) at the rate which would have been applicable had it not elected the alternative
package of benefits (generally 10%-25%, depending on the extent of foreign shareholders
holding its ordinary shares). In addition, the dividend recipient is taxed at the reduced
rate applicable to dividends from Approved Enterprises (15%), if the dividend is
distributed during the tax exemption period or within a specified period thereafter. We
must withhold this tax at source, regardless of whether the dividend is converted into
foreign currency. See Taxation of Ordinary SharesTaxation of Dividends
Paid On Ordinary Shares and Note 18 to the Consolidated Financial Statements.

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Subject
to certain provisions concerning income under the alternative package of benefits, all
dividends are considered to be attributable to the entire enterprise and the effective tax
rate on the dividends is the result of a weighted combination of the various applicable
tax rates. We are not obliged to distribute exempt retained profits under the alternative
package of benefits, and we may generally decide from which years profits to declare
dividends. We currently intend to reinvest the amount of our tax-exempt income and not to
distribute such income as a dividend.

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

Subject
to compliance with applicable requirements, income derived from our Approved Enterprise
facilities will be tax exempt for a period of two years after we have taxable income and
will be subject to a reduced rate of corporate tax of up to 25% depending on the extent of
foreign shareholders holding our ordinary shares for the following five years. Due to
cumulative losses for tax purposes, we have not yet utilized tax benefits derived from our
Approved Enterprise facilities.

B.
          Outline of the primary changes of the Encouragement Reform

The
Encouragement Reform provides that Approved Enterprise status will continue to
be granted by the Investment Center to qualifying investments. However, the Amendment
limits the scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as an Approved Enterprise, such as provisions
generally requiring that at least 25% of the Approved Enterprises income will be
derived from export.

The
Encouragement Reform also provides that Approved Enterprise status will only be necessary
for receiving grants from the Investment Center. As a result, it is no longer necessary
for a company to acquire Approved Enterprise status in order to receive the tax benefits
previously available under the alternative package of benefits. Rather, a company may
claim the tax benefits offered by the Investment Law as amended directly in its tax
returns, provided that its facilities meet the criteria for tax benefits set out by the
Amendment. Such companies are also no longer required to file reports with the Investment
Center. Companies are entitled to approach the Israeli Tax Authority for a pre-ruling
regarding their eligibility for benefits under the Encouragement Reform.

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Tax
benefits are available under the Encouragement Reform to production facilities (or other
eligible facilities), which are generally required to derive more than 25% of their
business income from export. In order to receive the tax benefits, the Encouragement
Reform states that the company must make an investment which meets all the conditions set
out in the Amendment for tax benefits and exceeds a minimum amount specified in the Law.
Such investment allows the company to receive a Benefited Enterprise status,
and may be made over a period of no more than three years ending on the end of the year in
which the company requested to have the tax benefits apply to the Benefited Enterprise
(the Year of Election). Where the company requests to have the tax benefits
apply to an expansion of existing facilities, only the expansion will be considered to be
a Benefited Enterprise and the companys effective tax rate will be the weighted
average of the applicable rates. In this case, the minimum investment required in order to
qualify as a Benefited Enterprise is required to exceed a certain percentage of the value
of the companys production assets before the expansion, as follows:

| | Production assets          | % of required investment | Required investment
| | -------------------------- | ------------------------ | -------------------
|
|
|
|
| | Up to NIS 140 million      |                          |                    
| | From NIS 140 - 500 million |                          |                    
| | Over NIS 500 million       |                          |                    

The
extent of the tax benefits available under the Amendment to qualifying income of a
Benefited Enterprise are determined by the geographic location of the Benefited
Enterprise. The location will also determine the period for which tax benefits are
available.

Dividends
paid out of income derived by a Benefited Enterprise will be treated similarly to payment
of dividends by an Approved Enterprise under the alternative package of benefits.
Therefore, dividends paid out of income derived by a Benefited Enterprise (or out of
dividends received from a company whose income is derived from a Benefited Enterprise) are
generally subject to withholding tax at the rate of 15% (deductible at source). The
reduced rate of 15% is limited to dividends and distributions out of income derived from a
Benefited Enterprise during the benefits period and actually paid at any time up to 12
years thereafter. A company qualifying for tax benefits under the Amendment which pays a
dividend out of income derived by its Benefited Enterprise during a period in which the
Benefited Enterprise was exempt from tax will be subject to tax in respect of the gross
amount of the dividend at the otherwise applicable rate of 25%, (or lower in the case of a
qualified company owned by a certain percentage of non-Israeli residents). The dividend
recipient would be subject to tax at the rate of 15% on the amount received which tax
would be deducted at source.

73

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

Under
the Law for the Encouragement of Industrial Research and Development, 1984, research and
development programs which meet certain criteria and are approved by the Research
Committee, a governmental committee of the Office of the Chief Scientist are eligible for
grants of up to 50% of the projects expenditure, as determined by the Research
Committee, in return for the payment of royalties from the sale of the product developed
in accordance with the program. Regulations promulgated under the Research Law generally
provide for the payment of royalties to the Chief Scientist ranging from 3% to 5% or in
some cases, such as ours, ranging from 4% to 6%, on revenues from products developed using
such grants until 100% of the dollar-linked grant is repaid. Following the full repayment
of the grant, there is no further liability for payment. See Item 5Operating
and Financial Review and Prospects and Note 18 to the Consolidated Financial
Statements.

The
terms of the Israeli government participation also require that the manufacture of
products developed with government grants be performed in Israel. However, under the
regulations promulgated under the Research Law, in the event that any of the manufacturing
is performed outside Israel by any entity other than us, if approval is received from the
Office of the Chief Scientist for such foreign manufacturing and the identity of the
foreign manufacturers, we may be required to pay increased royalties. If the manufacturing
volume that is performed outside of Israel is less than 50%, the total amount to be repaid
to the Office of the Chief Scientist may be adjusted to 120% of the grant. If the
manufacturing volume that is performed outside of Israel is between 50% and 90% the total
amount may be adjusted to 150% of the grant and if it is more than 90%, the total amount
may be adjusted to 300% of the grant. Since our manufacturing activities are performed by
subcontractors outside of Israel, the consent of the Office of the Chief Scientist is
required for these activities and additional consents will be required in connection with
the manufacturing of products developed in the future with Office of the Chief Scientist
grants. The letters of approval under which we received the grants do not specifically
refer to our manufacturing activities outside of Israel; however, we believe that the
Office of the Chief Scientist has adequately expressed its consent to such activities.
There can be no assurance that the consents granted to date by the Office of the Chief
Scientist will be deemed to be adequate under applicable laws and regulations or that such
consents will not be reversed or modified in any way or that we will obtain consents for
such activities at all from the Office of the Chief Scientist in the future. Failure to
comply with the requirements for consents for manufacturing outside of Israel could result
in penalties, cancellation of grants and denial of any future applications for grants or
for these consents. If the consents obtained from the Office of the Chief Scientist to
manufacture our products outside of Israel are terminated or if we are unable to obtain
similar consents in the future, our business could be harmed. A transfers of the
technology developed pursuant to the terms of these grants may be transferred outside of
Israel only subject to the payments promulgated under the Research Law and subject to the
prior approval of the Research Committee; technology transfers within Israel are also
subject to the prior approval of the Research Committee. Such approval is not required for
the export of any products resulting from such research or development. Approval of the
transfer of technology in Israel may be granted only if the recipient abides by all the
provisions of the Research Law and regulations promulgated thereunder, including the
restrictions on the transfer of know-how and production and the obligation to pay
royalties in an amount that may be increased. There can be no assurance that such consent,
if requested, will be granted under reasonable commercial terms. See Item
5Operating and Financial Review and ProspectsGovernment Grants.

74

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Effective
for grants received from the Office of the Chief Scientist under programs approved after
January 1, 1999, the outstanding balance of such grants will be subject to interest
equal to the 12 months LIBOR rate applicable to dollar deposits that is published on
the first business day of each calendar year.

As
governmental incentives, the funds generally available for grants from the Office of the
Chief Scientist may be reduced in the future and there is no assurance that the government
will not abolish such grants in the future. Even if these grants are maintained, there is
no assurance we will receive Office of the Chief Scientist grants in the future. In
addition, each application to the Office of the Chief Scientist is reviewed separately,
and grants are based on the program approved by the Research Committee. Generally,
expenditures supported under other incentive programs of the State of Israel are not
eligible for grants from the Office of the Chief Scientist. There is no assurance that
applications to the Office of the Chief Scientist will be approved and, until approved,
the amounts of any such grants are not determinable.

Tax Benefits and Grants
for Research and Development

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

Tax Benefits Under the
Law for the Encouragement of Industry (Taxes), 1969

According
to the Law for the Encouragement of Industry (Taxes), 1969, or the Industry
Encouragement Law, an Industrial Company is 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 certain government loans, capital gains, interest and
dividends), is derived from an Industrial Enterprise owned by it. An
Industrial Enterprise is defined as an enterprise whose major activity in a
given tax year is industrial production activity. We believe that we currently qualify as
an Industrial Company within the definition of the Industry Encouragement Law.

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Under
the Industry Encouragement Law, Industrial Companies are entitled to the following
preferred tax benefits:

(a)        deduction
of purchases of know-how and patents over an eight-year period for           tax
purposes;

(b)        right
to elect under certain conditions to file a consolidated tax return with
          additional related Israeli Industrial Companies;

(c)        accelerated
depreciation rates on equipment and buildings;

(d)        deduction
over a three-year period of expenses related to the issuance and           listing of
shares on a stock exchange;

Eligibility
for the benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority. No assurance can be given that we qualify or
that we will continue to qualify as an Industrial Company or that the benefits
described above will be available in the future.

Special Provisions
Relating to Taxation Under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985, generally referred to as the
Inflationary Adjustments Law, represents an attempt to overcome the problems
presented to a traditional tax system by an economy undergoing rapid inflation. The
Inflationary Adjustments Law is highly complex. Its features which are material to us can
be described as follows:

(a)       
          There is a special tax adjustment for the preservation of equity whereby certain
          corporate assets are classified broadly into fixed (inflation resistant) assets
          and non-fixed (soft) 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.

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

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Capital Gains Tax on
Sales of Our Ordinary Shares

Israeli
law generally imposes on residents and non-residents capital gains tax on the sale of
capital assets in Israel, including our ordinary shares, unless a specific exemption is
available or unless a tax treaty between Israel and the shareholders country of
residence provides otherwise.  The law distinguishes between the inflationary surplus
and the real gain.  The inflationary surplus is a portion of the total capital gain
which is equivalent to the increase of the relevant assets purchase price that is
attributable to the increase in the Israeli consumer price index or, in certain
circumstances, a foreign currency exchange rate, between the date of purchase and the date
of sale.  The real gain is the excess of the total capital gain over the inflationary
surplus.

On
January 1, 2006, an amendment to the Israeli tax regime became effective (the 2006
Tax Reform). The 2006 Tax Reform significantly changed the tax rates applicable to
income derived from shares.

According
to the 2006 Tax Reform, an individual is subject to a 20% tax rate on real capital gains
derived from the sale of shares, as long as the individual is not a substantial
shareholder (generally a shareholder with 10% or more of the right to profits, right
to nominate a director and voting rights) of the company issuing the shares. There will
generally be no capital gains tax on the inflationary surplus. The rate on the gains from
publicly traded shares applicable to gains that were realized before January 1, 2006 was
15%.

A
substantial shareholder will be subject to tax at a rate of 25% in respect of real capital
gains derived from the sale of shares issued by the company in which he or she is a
substantial shareholder. The determination of whether the individual is a substantial
shareholder will be made on the date that the securities are sold. In addition, the
individual will be deemed to be a substantial shareholder if at any time during the 12
months proceeding this date he had been a substantial shareholder.

With
respect to gains accrued before January 1, 2003, regulations promulgated under the Israeli
Income Tax Ordinance provided for an exemption from Israeli capital gains tax on gains
that were derived from the sale of shares of an Industrial Company, as defined
by the Industry Encouragement Law. This exemption only applied to shares that were traded
on specified non-Israeli markets, including the NASDAQ National Market, provided that the
sellers purchased their shares either in the companys initial public offering or in
public market transactions thereafter. The exemption did not apply to shareholders who are
in the business of trading securities, or to shareholders that are Israeli resident
companies and subject to the Income Tax Law (Inflationary Adjustments)  1985. We
believe that we are currently an Industrial Company, as defined by the Industry
Encouragement Law. There can be no assurance that the Israeli tax authorities will not
deny our status as an Industrial Company, possibly with retroactive effect.

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Non-Israeli
residents are exempt from Israeli capital gains tax on any gains derived from the sale of
shares in an Israeli corporation publicly traded on the TASE and/or on a foreign stock
exchange, provided such gains do not derive from a permanent establishment of such
shareholders in Israel and that such shareholders did not acquire their shares prior to
the issuers initial public offering. However, non-Israeli corporations will not be
entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or
more in such non-Israeli corporation, or (ii) is the beneficiary of or is entitled to 25%
or more of the revenues or profits of such non-Israeli corporation, whether directly or
indirectly.

In
some instances where our shareholders may be liable to Israeli tax on the sale of their
ordinary shares, the payment of the consideration may be subject to the withholding of
Israeli tax at the source.

Pursuant
to the treaty between the Governments of the United States and Israel with respect to
taxes on income, or the U.S.-Israel tax treaty, the sale, exchange or disposition of our
ordinary shares by a person who qualifies as a resident of the United States under the
treaty and who is entitled to claim the benefits afforded to him by the treaty, will
generally not be subject to Israeli capital gains tax. This exemption shall not apply to a
person who held, directly or indirectly, shares representing 10% or more of the voting
power in our company during any part of the 12-month period preceding the sale, exchange
or disposition, subject to certain conditions. A sale, exchange or disposition of our
shares by a U.S. resident qualified under the treaty, who held, directly or indirectly,
shares representing 10% or more of the voting power in our company at any time during the
preceding 12-month period would be subject to Israeli tax, to the extent applicable;
however, under the treaty, this U.S. resident would be permitted to claim a credit for
these taxes against the U.S. income tax with respect to the sale, exchange or disposition,
subject to the limitations in U.S. laws applicable to foreign tax credits.

# Taxation of Dividends

Non-residents
of Israel are subject to income tax on income accrued or derived from sources in Israel.  These
sources of income include passive income such as dividends, royalties and interest, as
well as non-passive income from services rendered in Israel.  On distributions of
dividends other than bonus shares, or stock dividends, to Israeli individuals and foreign
resident individuals and corporations we would be required to withhold income tax at the
rate of 20%.  If the income out of which the dividend is being paid is attributable
to an Approved Enterprise under the Law for the Encouragement of Capital Investments,
1959, the rate is 15%.  A different rate may be provided for in a treaty between
Israel and the shareholders country of residence.  Under the U.S.-Israel tax
treaty, if the income out of which the dividend is being paid is not attributable to an
Approved Enterprise, then income tax with respect to shareholders that are U.S.
corporations holding at least 10% of our voting power in the twelve-month period
preceding the distribution of such dividends, is required to be withheld at the rate of
12.5%.

Foreign Exchange Regulations

Dividends
(if any) paid to the holders of our Ordinary Shares and any amounts payable upon our
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 freely converted into dollars at the rate of exchange
prevailing at the time of conversion. Because exchange rates between the NIS and the
dollar fluctuate continuously, a U.S. shareholder will be subject to the risk of currency
fluctuations between the date when we declare NIS-denominated dividends and the date when
we pay them in NIS.

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# F. Dividends and Paying
Agents

Not
applicable.

# G. Statements by Experts.

Not
applicable.

# H. Documents on Display

We
are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligation with respect to
such requirements by filing reports with the Securities and Exchange Commission. You may
read and copy any document we file with the Securities and Exchange Commission without
charge at the Securities and Exchange Commissions public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of such material may be obtained by mail from
the Public Reference Branch of the Securities and Exchange Commission at such address, at
prescribed rates. Please call the Securities and Exchange Commission at l-800-SEC-0330 for
further information on the public reference room.

As a foreign private issuer, we are
exempt from the rules under the Exchange Act prescribing the furnishing and content of
proxy statements, and our officers, directors and principal shareholders are exempt from
the reporting and short-swing profit recovery provisions contained in Section
16 of the Exchange Act. In addition, we are not required under the Exchange Act to file
periodic reports and financial statements with the Securities and Exchange Commission as
frequently or as promptly as United States companies whose securities are registered under
the Exchange Act. A copy of each report submitted in accordance with applicable United
States law is available for public review at our principal executive offices.

# I. Subsidiary Information

Not
applicable.

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|ITEM 11. | Quantitative
and Qualitative Disclosures About Market Risk
|-------- | ----------------------------------------------------------

Market
risk represents the risk of changes in the value of a financial instrument caused by
fluctuations in interest rates, equity prices and foreign exchange rates.

# Interest Rate Risk

We
are exposed to interest rate volatility primarily relating to interest rate changes
applicable to our withdrawals under our credit lines. Our credit lines bear interest at
rates, which vary with changes in LIBOR. We do not speculate on the future direction of
such interest rates. On March 2004, the Company reached an agreement with its principal
bank lenders for the repayment of $6.55 million and the deferral of repayment of long-term
loans totaling $1.5 million until the years 2005, 2006 and 2007. As of December 31,
2006, current maturities of long  term loans, $ 0.5 million bore interest at
variable rates. The weighted average interest rates on short-term bank credit (linked to
the U.S. dollar) as at December 31, 2006, 2005 and 2004 are 6.9%, 5.4% and 3.85,
respectively. As of December 31, 2006, the interest expenses we attributed to the
utilization of our credit lines amounted to $36,000. Interest risk is estimated as the
potential increase in interest expenses from a hypothetical 10% increase in the interest
rates. Assuming a hypothetical 10% increase, our interest expenses would increase by
$3,000.

# Equity Price Risk

As
of December 31, 2006, we did not have any marketable securities that were recorded at a
fair value; hence there was no exposure to equity price risk

# Foreign Currency
Exchange Risk

As
of December 31, 2006, we had cash and cash equivalents in New Israeli Shekels (NIS) or in
funds linked thereto in the amount of $636,000 (out of $3.4 million in cash and cash
equivalents that we had in total). Market risk is estimated as the potential decrease in
fair value resulting from a hypothetical 10% increase in the year-end dollar exchange
rate. Assuming such increase in the dollar exchange rate, the fair value of our cash and
cash equivalents would decrease immaterially by $58,000. As of December 31, 2006,
we had accounts receivable in New Israeli Shekels (NIS) or in funds linked thereto in the
amount of $72,000. Market risk is estimated as the potential decrease in fair value
resulting from a hypothetical 10% increase in the year-end dollar exchange rate. Assuming
such increase in the dollar exchange rate, the fair value of our accounts receivable would
decrease by $7,000. As of December 31, 2006, we had other receivables in New Israeli
Shekels (NIS) or in funds linked thereto in the amount of $28,000. Market risk is
estimated as the potential decrease in fair value resulting from a hypothetical 10%
increase in the year-end dollar exchange rate. Assuming such increase in the dollar
exchange rate, the fair value of our accounts receivable would decrease by $3,000.As of December 31, 2006, we had accounts payable in New Israeli Shekels (NIS) or in
funds linked thereto in the amount of $617,000. Market risk is estimated as the potential
increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar
exchange rate. Assuming such a decrease in the Dollar exchange rate, the fair value of our
accounts payable would increase by $56,000. As of December 31, 2006, we had other payable
in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $1,302,000.
Market risk is estimated as the potential increase in fair value resulting from a
hypothetical 10% decrease in the year-end dollar exchange rate. Assuming such a decrease
in the dollar exchange rate, the fair value of our accounts payable would increase by
$118,000. As of December 31, 2006, we had long-term payable in New Israeli Shekels (NIS)
or in funds linked thereto in the amount of $320,000. Market risk is estimated as the
potential increase in fair value resulting from a hypothetical 10% decrease in the
year-end dollar exchange rate. Assuming such a decrease in the dollar exchange rate, the
fair value of our accounts payable would increase by $29,000.

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As
of December 31, 2006, we had cash and cash equivalents in Singapore dollars or SGD or in
funds linked thereto in the aggregate amount of $176,000. Market risk is estimated as the
potential decrease in fair value resulting from a hypothetical 10% increase in the
year-end dollar/SGD exchange rate. Assuming such an increase in the dollar/SGD exchange
rate, the fair value of our SGD accounts receivable would decrease by $16,000. As of
December 31, 2006 we had accounts receivable in SGD or in funds linked thereto in the
aggregate amount of $55,000. Market risk is estimated as the potential decrease in fair
value resulting from a hypothetical 10% increase in the year-end dollar/SGD exchange rate.
Assuming such an increase in the dollar/SGD exchange rate, the fair value of our SGD
accounts receivable would decrease by $5,000. As of December 31, 2006 we had other
receivable and other payable in SGD or in funds linked thereto in the aggregate amount of
$8,000 and $16,000, respectively. Market risk is estimated as the potential decrease in
fair value resulting from a hypothetical 10% increase in the year-end dollar/SGD exchange
rate. Assuming such an increase in the dollar/SGD exchange rate, the results of operations
of the Company would not have any material effect.

As
of December 31, 2006, we had cash and cash equivalents in Euro or in funds linked thereto
in the aggregate amount of $115,000. Market risk is estimated as the potential increase in
fair value resulting from a hypothetical 10% decrease in the year-end dollar/Euro exchange
rate. Assuming such a decrease in the dollar/Euro exchange rate, the fair value of our
other payables in Euro would increase by $10,000. As of December 31, 2006, we had accounts
receivable in Euro or in funds linked thereto in the aggregate amount of $1,035,000.
Market risk is estimated as the potential decrease in fair value resulting from a
hypothetical 10% increase in the year-end dollar/ Euro exchange rate. Assuming such an
increase in the dollar/SGD exchange rate, the fair value of our Euro accounts receivable
would decrease by $94,000. As of December 31, 2006, we had account payables in Euro or in
funds linked thereto in the aggregate amount of $73,000. Market risk is estimated as the
potential increase in fair value resulting from a hypothetical 10% decrease in the
year-end dollar/Euro exchange rate. Assuming such a decrease in the dollar/Euro exchange
rate, the fair value of our other payables in Euro would increase by $7,000.As of December
31, 2006, we had other payables in Euro or in funds linked thereto in the aggregate amount
of $217,000. Market risk is estimated as the potential increase in fair value resulting
from a hypothetical 10% decrease in the year-end dollar/Euro exchange rate. Assuming such
a decrease in the dollar/Euro exchange rate, the fair value of our other payables in Euro
would increase by $20,000.

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# PART II

|ITEM 12. | Description
of Securities Other Than Equity Securities
|-------- | ------------------------------------------------------

Not
applicable.

|ITEM 13. | Defaults,
Dividend Arrearages And Delinquencies
|-------- | -----------------------------------------------

Not
applicable.

|ITEM 14. | Material
Modifications to the Rights of Security Holders and Use of Proceeds
|-------- | ----------------------------------------------------------------------------

Not
applicable.

|ITEM 15. | Controls
and Procedures
|-------- | -----------------------

We
have established and maintain disclosure controls and procedures that are designed to
ensure that material information relating to us that we file or submit under the
Securities Exchange Act of 1934 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 is accumulated and communicated to the companys
management, including its Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.

As
of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and operation of
disclosure controls and procedures. Based on that evaluation of these disclosure controls
and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31, 2006.

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The
Chief Executive Officer and Chief Financial Officer have also concluded that there were no
significant changes in the our internal controls or in other factors that could
significantly affect the internal controls subsequent to the date that the evaluation was
completed, including any corrective actions with regard to significant deficiencies and
material weaknesses.

|ITEM 16 | Reserved
|------- | --------

|ITEM 16A | Audit
Committee Financial Expert
|-------- | --------------------------------

Our
board of directors has determined that Orit Stav is our audit committee financial expert.

83

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|ITEM 16B | Code
of Ethics
|-------- | --------------

On
May 13, 2004, our company adopted a code of ethics, which applies to all of our employees,
officers and directors, including our chief executive officer, our chief financial officer
and our principal accounting officer or controller or other persons performing similar
functions.

Copies
of our code of ethics will be available at our executive offices upon request.

|ITEM 16C | Principal
Accountant Fees and Services
|-------- | --------------------------------------

The
following table presents fees for professional audit services rendered by Somekh Chaikin,
a member of KPMG International (independent auditors) for the audit of the Companys
consolidated annual financial statements for the years ended December 31, 2006 and
2005, and fees billed for other services rendered by Somekh Chaikin, a member of KPMG
International (independent auditors).

|                      | 2006 | 2005
|--------------------- | ---- | ----
|
|
|
|
|Audit Fees(1)         |      |     
|Audit-Related Fees(2) |      |     
|Tax Fees(3)           |      |     
|All Other Fees(4)     |      |     

|(1) | Audit
fees consist of fees for professional services rendered for the audit of the Companys
Consolidated Financial Statements and review of financial statements and services
normally provided by the independent auditor in connection with statutory and regulatory
filings or engagements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Audit-related
fees are fees principally for assurance and related services that are not reported under
Audit Fees.
|--- | ------------------------------------------------------------------------------------------------------------------

|(3) | Tax
fees consist of tax compliance fees for the preparation of original and           amended
tax returns, claims for refunds and tax advice.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Fees
          regarding due diligence of a company BVR considered of buying.
|--- | -----------------------------------------------------------------------------

Pre-approval Policies and
procedures

The
audit committee approves all audit, audit-related services, tax services and other
services provided by KPMG. Any services provided by KPMG that are not specially included
within the scope of the audit must be pre-approved by our audit committee prior to any
engagement.

84

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|ITEM 16D | Exemptions
from the Listing and Standards of Audit Committees
|-------- | -------------------------------------------------------------

Not
applicable.

|ITEM 16E | Purchases
of Equity Securities by the Issuer and Affiliated Purchasers
|-------- | ----------------------------------------------------------------------

For
information relating to the purchase of our securities by Chun LP see Item 7 
Major Shareholders and Related Party Transactions  B. Related Party
Transactions.

# PART III

|ITEM 17 | Financial
Statements
|------- | --------------------

The
Financial Statements required by this item are found at the end of this Annual Report,
beginning on page F-1.

|ITEM 18 | Financial
Statements
|------- | --------------------

We have responded to Item 17 in lieu
of this item

85

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

The
exhibits filed with or incorporated into this annual report are listed on the index of
exhibits below.

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

|1.1* |  | Memorandum
of Association of Registrant
|---- |  | ---------------------------------------

|1.2* |  | Form
of Articles of Association
|---- |  | -------------------------------

|4.1** |  | Management
Services Agreement, dated March 18, 2002, between the Registrant and Elisra Electronic
System Ltd. (an                          English summary accompanied by Hebrew original)
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2*** |  | Management
Services Agreement, dated April 6, 2003, between the Registrant and Elisra Electronic
System Ltd. (an                          English summary accompanied by Hebrew original)
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Lease
Agreement, dated September 14, 1999, as amended, between BVR Technologies Ltd. and Minrav
Holdings Ltd. (an                          English summary accompanied by Hebrew original)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | Lease
Agreement, dated August 29, 1999, between the Registrant and Electra Real Estate Ltd.(an
English summary                          accompanied by Hebrew original)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5**** |  | Share
Purchase Agreement, dated March 1, 2004 between the Registrant and the purchasers
identified therein
|------- |  | ----------------------------------------------------------------------------------------------------------

|4.6**** |  | Cooperation
Agreement, dated August 11, 2005, between the Registrant and Israel Aircraft Industries
on behalf of                          MLM. As this addendum is written in Hebrew, a
translation is attached hereto.
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7**** |  | Share
Purchase Agreement, dated March 5, 2006 between the Registrant and Nir Dor on behalf of
H.S.N General                          Managers Holdings L.P., an Israeli Limited
Partnership.
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8 |  | Subsidiaries
of the Registrant
|-- |  | ------------------------------

|10.1 |  | Consent
of Independent Registered Public Accounting firm.
|---- |  | ---------------------------------------------------------

|12.1 |  | Certification
by Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
|---- |  | --------------------------------------------------------------------------------------------------

|12.2 |  | Certification
by Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
|---- |  | --------------------------------------------------------------------------------------------------

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

86

---

---



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

---

|    
Incorporated
by reference to the annual report on Form 20-F for the year ended December 31, 2000.
|-------------------------------------------------------------------------------------------------------

*     Incorporated
by reference to the Registration Statement on Form 20-F (Commission File No. 0-29884).

**     Incorporated
by reference to the annual report on Form 20-F for the year ended December 31, 2001.

***     Incorporated
by reference to the annual report on Form 20-F for the year ended December 31, 2002.

****     Incorporated
by reference to the annual report on Form 20-F for the year ended December 31, 2000.

87

---

---



SIGNATURE

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.

| |  | B.V.R. SYSTEMS (1998) LTD.By: /s/ Ilan Gillies
Ilan GilliesChief Executive       Officer
| |  | ------------------------------------------------------------------------------------------------------

| |  | By: /s/ Reuven Shahar 
Reuven Shahar Chief Financial Officer
| |  | --------------------------------------------------------------------------

Date: May 10, 2007

88

---

---

# B.V.R. Systems (1998)
Ltd.

# Financial StatementsAs
 of and For The Year Ended December 31, 2006



---

---



|B.V.R. Systems (1998) Ltd.                               
|---------------------------------------------------------
|                                                         
|Consolidated Financial Statements as of December 31, 2006
|                                                         

Contents

|                                                                        | Page      
|----------------------------------------------------------------------- | ----------
|
|
|
|
|Report of Independent Registered Public Accounting Firm                 | F-2       
|                                                                       
|Consolidated Balance Sheets as of December 31, 2006 and 2005            | F-3 - F-4 
|                                                                       
|Consolidated Statements of Operations for the years                    
|ended December 31, 2006, 2005 and 2004                                  | F-5       
|                                                                       
|Consolidated Statement of Changes in Shareholders' Equity for the years
|ended December 31, 2006, 2005 and 2004                                  | F-6       
|                                                                       
|Consolidated Statements of Cash Flows for the years                    
|ended December 31,2006, 2005 and 2004                                   | F-7 - F-8 
|                                                                       
|Notes to Consolidated Financial Statements                              | F-9 - F-41



---

---



# Report of Independent
Registered Public Accounting FirmTo the Shareholders of B.V.R. Systems (1998) Ltd.

We have audited the accompanying
consolidated balance sheets of B.V.R. Systems (1998) Ltd. (the Company) and its subsidiary
as of December 31, 2006 and 2005, and the related consolidated statements of operations,
changes in shareholders equity and cash flows for each of the years in the
three-year period ended December 31, 2006. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiary as of December 31, 2006
and 2005, and the consolidated results of their operations, changes in shareholders
equity and their cash flows for each of the years in the three-year period ended December
31, 2006, in conformity with generally accepted accounting principles in Israel.

As discussed in Notes 2O and 2T to
the consolidated financial statements, effective January 1, 2006, the Company changed its
method of accounting for share-based compensation upon adoption of Israeli Accounting
Standard No. 24 Share-Based Payments.

Accounting principles generally
accepted in Israel vary in certain significant respects from accounting principles
generally accepted in the United States of America. Information relating to the nature and
effect of such differences is presented in Note 21 to the consolidated financial
statements. As described in Note 21B, the Company has restated its statements of net
income for the years ended December 31, 2005 and 2004.

Somekh Chaikin
Certified Public Accountants (Isr.)
Member Firm of KPMG International

Tel Aviv, Israel

May 10, 2007

F - 2

---

---



|B.V.R. Systems (1998) Ltd.                   
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as of December 31
|                                             

|                                       |  | 2006 | 2005
|-------------------------------------- |  | ---- | ----
|
|
|
|
|Assets                                 |  |      |     
|                                       |  |     
|Current assets                         |  |     
|Cash and cash equivalents              |  |      |     
|Restricted bank deposits               |  |      |     
|Trade receivables                      |  |      |     
|Other receivables and prepaid expenses |  |      |     
|Inventories                            |  |      |     
|                                       |  |      |     
|                                       |  |     
|Total current assets                   |  |      |     
|                                       |  |      |     
|                                       |  |     
|Other non-current assets               |  |      |     
|                                       |  |      |     
|                                       |  |     
|Fixed assets, net                      |  |      |     
|                                       |  |      |     
|                                       |  |     
|Other assets, net                      |  |      |     
|                                       |  |      |     
|                                       |  |     
|Total assets                           |  |      |     
|                                       |  |      |     

|/s/ Aviv Tzidon

Aviv TzidonChairman of the Board of Directors | /s/ Ilan Gillies

Ilan GilliesPresident and ChiefExecutive Officer | /s/ Reuven Shahar

Reuven ShaharChief Financial Officer
|---------------------------------------------------------------------------- | -------------------------------------------------------------------------------- | ---------------------------------------------------------------------

Approval date of the financial statements:  May 10, 2007

F - 3

---

---



|B.V.R. Systems (1998) Ltd.                   
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as of December 31
|                                             

|                                                  |  | 2006 | 2005
|------------------------------------------------- |  | ---- | ----
|
|
|
|
|Liabilities and Shareholders' equity              |  |      |     
|                                                  |  |     
|Current liabilities                               |  |     
|Current maturities of long-term bank loans        |  |      |     
|Short-term loan                                   |  |      |     
|Trade payables                                    |  |      |     
|Excess of advances from customers over amounts    |  |     
|recognized as revenue                             |  |      |     
|Other payables and accrued expenses               |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Total current liabilities                         |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Long-term liabilities                             |  |     
|Long-term bank loans                              |  |      |     
|Long-term payable in respect of income tax        |  |      |     
|Liability for employee severance benefits, net    |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Total long-term liabilities                       |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Commitments and contingencies                     |  |      |     
|                                                  |  |     
|Shareholders' equity                              |  |      |     
|Share capital:                                    |  |     
|Ordinary shares, NIS 1.00 par value               |  |     
|400,000,000 and 200,000,000 shares authorized,    |  |     
|116,863,757and 95,863,757  shares issued,         |  |     
|and 116,863,757 and 95,663,757 shares outstanding |  |     
|as of December 31, 2006 and 2005, respectively    |  |      |     
|Additional paid-in capital                        |  |      |     
|Accumulated deficit                               |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Total shareholders' equity                        |  |      |     
|                                                  |  |      |     
|                                                  |  |     
|Total liabilities and shareholders' equity        |  |      |     
|                                                  |  |      |     

|* | Restated
(See Note 2T)
|- | ----------------------

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

F - 4

---

---



|B.V.R. Systems (1998) Ltd.                                           
|---------------------------------------------------------------------
|                                                                     
|Consolidated Statements of Operations for the years ended December 31
|                                                                     

|                                                    |  | 2006 | 2005 | 2004
|--------------------------------------------------- |  | ---- | ---- | ----
|
|
|
|
|Revenues:                                           |  |      |      |     
|Sales                                               |  |      |      |     
|Royalties and commissions                           |  |      |      | 16A 
|                                                    |  |      |      |     
|                                                    |  |     
|Total revenues                                      |  |      |      | 19A 
|                                                    |  |     
|Cost of revenues                                    |  |      |      | 19B 
|                                                    |  |      |      |     
|                                                    |  |     
|Gross profit                                        |  |      |      |     
|                                                    |  |      |      |     
|                                                    |  |     
|Operating expenses:                                 |  |     
|Research and development                            |  |      |      |     
|Selling and marketing                               |  |      |      |     
|General and administrative                          |  |      |      |     
|                                                    |  |      |      |     
|                                                    |  |     
|Operating profit (loss)                             |  |      |      |     
|                                                    |  |      |      |     
|Financial expenses, net                             |  |      |      | 19C 
|Other income (expenses), net                        |  |      |      | 19D 
|                                                    |  |      |      |     
|                                                    |  |     
|Profit (loss) before income taxes                   |  |      |      |     
|Income tax expense                                  |  |      |      | 17  
|                                                    |  |      |      |     
|                                                    |  |     
|Net profit (loss) for the year                      |  |      |      |     
|                                                    |  |      |      |     
|                                                    |  |     
|Profit (loss) per share:                            |  |     
|Basic and diluted profit (loss) per share (in US $) |  |      |      |     
|                                                    |  |      |      |     
|                                                    |  |     
|Weighted-average number of ordinary                 |  |     
|shares of nominal NIS 1.00 par value                |  |     
|outstanding (in thousands) used in                  |  |     
|calculation of the basic and diluted profit         |  |     
|(loss) per share                                    |  |      |      |     
|                                                    |  |      |      |     

|* | Restated
(see Note 2T).
|- | -----------------------

|(1) | Reclassified
|--- | ------------

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

F - 5

---

---



|B.V.R. Systems (1998) Ltd.                  
|--------------------------------------------
|                                            
|Statement of Changes in Shareholders' Equity
|                                            

|                               | Number of
Ordinary Shares
outstanding
(NIS 1 par value) | Share capital | Additional
paid-in capital | Accumulated
deficit | Total
shareholders'
equity
|------------------------------ | ------------------------------------------------------- | ------------- | -------------------------- | ------------------- | --------------------------
|
|
|
|
|Balance as of                  |                                                         |               |                            |                     |                           
|January 1, 2004                |                                                         |               |                            | 10,660,874          |                           
|                               |                                                         |              
|Issuance of shares and options |                                                         |               |                            | 66,872,669          |                           
|Issuance of shares in          |                                                         |              
|respect of services            |                                                         |               |                            | 200,000             |                           
|Exercise of stock options      |                                                         |               |                            | 17,666,667          |                           
|Net loss for the year          |                                                         |               |                            | -                   |                           
|                               |                                                         |               |                            |                     |                           
|                               |                                                         |              
|Balance as of                  |                                                         |              
|December 31, 2004              |                                                         |               |                            | 95,400,210          |                           
|                               |                                                         |              
|Issuance of shares             |                                                         |              
|in respect of services         |                                                         |               |                            | 263,547             |                           
|Employee stock option          |                                                         |              
|compensation                   |                                                         |               |                            | -                   |                           
|Net profit for the year        |                                                         |               |                            | -                   |                           
|                               |                                                         |               |                            |                     |                           
|                               |                                                         |              
|Balance as of                  |                                                         |              
|December 31, 2005              |                                                         |               |                            | 95,663,757          |                           
|                               |                                                         |              
|Issuance of shares             |                                                         |              
|in respect of services         |                                                         |               |                            | 1,200,000           |                           
|Issuance of shares and         |                                                         |              
|warrants                       |                                                         |               |                            | 20,000,000          |                           
|Employee stock option          |                                                         |              
|compensation                   |                                                         |               |                            | -                   |                           
|Net loss for the year          |                                                         |               |                            | -                   |                           
|                               |                                                         |               |                            |                     |                           
|                               |                                                         |              
|Balance as of                  |                                                         |              
|December 31, 2006              |                                                         |               |                            | 116,863,757         |                           
|                               |                                                         |               |                            |                     |                           

|* | Restated
(see Note 2T)
|- | ----------------------

|** | Net
of issuance expenses of US$ 243 thousand
|-- | --------------------------------------------

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

F - 6

---

---



|B.V.R. Systems (1998) Ltd.           
|-------------------------------------
|                                     
|Consolidated Statements of Cash Flows
|                                     

|                                                             | Year ended December 31
|------------------------------------------------------------ | ----------------------
|
|
|
|
|Cash flows from operating activities                         |                       
|Net profit (loss) for the year                               |                       
|Adjustments to reconcile net profit (loss) to net cash flows |                       
|from operating activities (A)                                |                       
|                                                             |                       
|                                                             |                       
|Net cash (used in) provided by operating activities          |                       
|                                                             |                       
|                                                             |                       
|Cash flows from investing activities                         |                       
|Purchases of fixed assets                                    |                       
|Proceeds from sale of fixed assets                           |                       
|Decrease in long-term deposits                               |                       
|Decrease (increase) in restricted bank deposits              |                       
|Other assets                                                 |                       
|Changes in loans to employees                                |                       
|                                                             |                       
|                                                             |                       
|Net cash used in investing activities                        |                       
|                                                             |                       
|                                                             |                       
|Cash flows from financing activities                         |                       
|Short-term bank credit, net                                  |                       
|Repayment of short-term loan from related party              |                       
|Repayment of long-term loans from related parties            |                       
|Repayment of long-term loans from banks                      |                       
|Issuance of shares                                           |                       
|Exercise of stock options and warrants                       |                       
|                                                             |                       
|                                                             |                       
|Net cash provided by (used in) financing activities          |                       
|                                                             |                       
|                                                             |                       
|Increase in cash and cash equivalents                        |                       
|Cash and cash equivalents at the beginning of the year       |                       
|                                                             |                       
|                                                             |                       
|Cash and cash equivalents at the end of the year             |                       
|                                                             |                       

|* | Restated
(see Note 2T)
|- | ----------------------

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

F - 7

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Consolidated Statements of Cash Flows (cont'd)
|                                              

|                                                          | Year ended December 31
|--------------------------------------------------------- | ----------------------
|
|
|
|
|A.   Adjustments to reconcile net profit (loss) to net    |                       
|cash flows from operating activities                      |                       
|                                                          |                       
|Income and expenses not involving cash flows:             |                       
|Gain on sale of fixed assets                              |                       
|Depreciation and amortization                             |                       
|Stock based compensation                                  |                       
|Increase (decrease) in liability for employee             |                       
|severance benefits, net                                   |                       
|Forgiveness of debt                                       |                       
|Services in exchange for shares issuance                  |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|Changes in operating asset and liability items:           |                       
|Decrease (increase) in trade receivables                  |                       
|Decrease in other receivables and prepaid expenses        |                       
|Increase (decrease) in excess of advances from customers  |                       
|over amount recognized as revenue                         |                       
|Decrease in inventories                                   |                       
|Decrease in trade payables                                |                       
|Decrease in other payables and accrued expenses           |                       
|(current and non-current)                                 |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|                                                          |                       
|B.   Non-cash transactions                                |                       
|                                                          |                       
|Accounts payable in respect of fixed assets               |                       
|                                                          |                       
|                                                          |                       
|Prepaid expenses in respect of share issuance             |                       
|                                                          |                       
|                                                          |                       
|Conversion of short-term bank credit and long-term        |                       
|loans from related parties into share capital, additional |                       
|paid-in capital and options                               |                       
|                                                          |                       

|* | Restated
(see Note 2T)
|- | ----------------------

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

F - 8

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 1  General

| | A. | B.V.R.
Systems (1998) Ltd. (Company), an Israeli incorporated
               company, was formed on January 6, 1998 in order to receive all of the
assets and                liabilities of the defense-related business of B.V.R.
Technologies Limited                (BVR Tech), a company formed in 1986,
which were spun off to the                Company on October 23, 1998 in exchange for the
Companys shares issued to                the then shareholders of BVR Tech. In June
1998, the Company formed a subsidiary                in Singapore, BVR-S Pacific PTE,
which operates in Singapore.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is engaged in developing, manufacturing and marketing of advanced training and
computer-based simulation systems for military applications.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys business is exposed to numerous risks including product development,
technological advancement and the introduction of these products to the worlds
markets. Companies engaged in this field are required to invest significant resources and
constantly update products. The future success of the Company is dependent upon the
technological sophistication, price and quality of its products, and the provision of
solutions to meet customers needs in comparison to competitors. The principal
markets for the Companys products are mainly Europe, Israel and the Far East. Most
of the Companys customers are either government institutions or entities controlled
by governments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | In
December 2003, Chun Holding L.P. (Chun), a limited partnership
               controlled by Aviv Tzidon, Aeronautics Defense Systems Ltd. and Prescient
               Systems & Technologies Pte. Ltd., gained control of the Company by
               purchasing the Companys shares through a tender offer, from other
               shareholders and through a share issuance in March 2004 (see Note 15C for
more                details). As of December 31, 2006, Chun holds approximately 50% of
the                outstanding shares of the Company.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | At
December 31, 2006, the Company has working capital of $3.5 million, and cash
               and cash equivalents balance of $3.4 million, compared to cash and cash
               equivalents balance of $3.1 million at December 31, 2005. In addition,
during                the year ended December 31, 2006, the Companys total revenues
from sales,                commissions and royalties totaled $10.1 million compared to
$19.2 million during                2005, with a negative cash flow from operations
during 2006 of $2.4 million.                Based on current forecasts, management
believes that the Company has sufficient                liquidity to finance operations
for the next twelve months.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies

| | The
financial statements have been prepared in accordance with generally accepted accounting
principles in Israel. See Note 21 for reconciliation to accounting principles generally
accepted in the United States.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A. | Financial
statements in U.S. dollars
| | -- | ------------------------------------

| | The
currency of the primary economic environment in which the operations of the Company and
its subsidiary are conducted is the U.S. dollars (Dollar, or $).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
majority of the Companys sales are made outside Israel in dollars, and a
substantial portion of the Companys costs are incurred in dollars. Accordingly, the
Company has determined that the dollar is the currency of its primary economic
environment and thus its functional currency.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys transactions and balances denominated in dollars are presented at their
original amounts. Transactions denominated in currencies other than dollars are
translated into dollars using current exchange rates. All foreign currency transaction
gains and losses are reflected in the statements of operations as financial income or
expenses, as appropriate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the accounts of the Company and its wholly
owned subsidiary. All intercompany transactions and balances were eliminated in
consolidation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Use
of estimates
| | -- | ----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and expenses
during the reporting period. These are managements best estimates based on
experience and historical data. Actual results could differ from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Cash
equivalents and restricted bank deposits
| | -- | ---------------------------------------------

| | The
Company considers all highly liquid investments with a maturity of three months or less
from date of purchase, to be cash equivalents.
| | ------------------------------------------------------------------------------------------------------------------------------------------

| | Restricted
bank deposits are comprised of cash deposited in banks in respect of bank guarantees
granted to the Companys customers as partial collateral for the continued
performance of work and advances received from the customers. The withdrawal of these
deposits is based on the progress of the work and is subject to customer approval. The
Company recorded liens on these deposits in favor of the banks that granted the
guarantees. The restricted deposits are linked to the U.S. dollar and bear annual
interest of 4.66%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | E. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or market value. Cost is determined as follows:
| | -------------------------------------------------------------------------------------------

| |                              |                                             
| | ---------------------------- | --------------------------------------------
|
|
|
|
| | Raw materials and components | - On the "first-in, first-out" method       
| | Finished products            | - On the basis of actual manufacturing cost.

| | F. | Trade
receivables
| | -- | -----------------

| | Open
accounts include amounts billed to customers relating to transactions arising in the
ordinary course of business. Customers of the Company in the context of long-term
contracts are billed in accordance with milestones determined in the agreements. In
respect of the majority of the contracts, advances are paid upon the signing of the
contract.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Allowance
for doubtful accounts
| | -- | -------------------------------

| | The
financial statements include an allowance which Management believes adequately reflects
the loss inherent in receivables for which collection is in doubt. In determining the
adequacy of the allowance Management based its estimate on information at hand about
specific debtors, including their financial situation, aging of the receivable and
evaluation of the security received from them or their guarantors, if any.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | H. | Fixed
assets
| | -- | ------------

| | Fixed
assets are stated at cost less accumulated depreciation and amortization. Depreciation
and amortization are calculated using straight-line method using annual rates and periods
as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                   | %                                                
| | --------------------------------- | -------------------------------------------------
|
|
|
|
| | Computer and electronic equipment | 20 - 33.3                                        
| | Manufacturing equipment           | 10 - 15                                          
| | Office equipment                  | 6 - 15                                           
| | Leasehold improvements            | The shorter of the estimated useful lives and the
| |                                   | lease term of the related leasehold              

F - 11

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | I. | Revenue
recognition
| | -- | -------------------

| | (1) | Recognition
of revenues and costs from long-term contracts
| | --- | ----------------------------------------------------------

| | Revenue
and costs from work in progress under long-term contracts are recognized in accordance
with Israeli Accounting Standard No. 4 as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Revenues
and costs from work performed under long-term contracts are recognized
          according to the percentage-of-completion method, if all of the
          following conditions are fulfilled: the revenues are known or capable of being
          reliably estimated, collection of the revenues is probable, the costs involved
          with execution of the work are known or capable of being reliably estimated,
          there is no material uncertainty regarding the ability to complete the work and
          comply with the contractual terms with the customer and the rate of completion
          can be reliably estimated. If the conditions enumerated above are not met,
          income is recognized at the level of the costs incurred and expected to be
          recovered (zero margin).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
percentage of completion is measured on the basis of cost (the ratio of the
          costs incurred to the total estimated costs). Work in progress under long-term
          contracts is stated at cost less amounts charged to cost of revenues in the
          statement of operations and associated with revenue recognized on the basis of
          the percentage-of-completion method. Cost includes direct costs of
          materials, labor, subcontractor and other direct costs and allocated indirect
          manufacturing costs.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Anticipated
losses on contracts are provided for in full when determined to be           expected.
| | -- | --------------------------------------------------------------------------------------------------

| | d. | Estimated
profit or loss from long-term contracts may change due to changes in           estimates
resulting from differences between actual performance and original           forecasts.
The effect of such changes in estimates is recognized in the           statement of
operations at the time of their identification.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | The
Company provides warranties on sales of systems to certain customers for
          periods of up to 24 months, however not beyond the date of sale. The expenses
          related to the warranty period are taken into consideration in the direct cost
          of the contracts, based on managements estimation and in accordance with
          the Companys prior experience.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Revenue
from royalties and commissions
| | --- | --------------------------------------

| | Royalties
and commission revenues resulting from the cooperation agreement with Israel Aircraft
Industries Ltd. (IAI) (see Note 16A for more details), are being recognized
when the related payments are received by IAI. The Company determines such revenues by
receiving confirmation of payments subject to royalties and commissions from IAI.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | J. | Research
and development costs
| | -- | ------------------------------

| | Research
and development costs are charged to the statement of operations, as incurred.
| | ---------------------------------------------------------------------------------------

| | K. | Selling
and marketing costs
| | -- | ---------------------------

| | Selling
and marketing costs are charged to selling and marketing expenses in the statement of
operations.
| | ---------------------------------------------------------------------------------------------------------

| | L. | Income
taxes
| | -- | ------------

| | Income
taxes for all periods presented have been computed on the basis of income tax rates
applicable to the Company and its subsidiary as separate stand-alone entities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounts for income taxes under the liability method of accounting.
| | -------------------------------------------------------------------------------

| | Under
the liability method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities, as well
as loss carry forwards, and are measured using the prevailing tax rates and laws that
will be in effect when the differences are expected to be utilized. The main factors, in
respect of which deferred taxes were not calculated is the realization of investment in a
subsidiary that management intends to retain. Similarly, deferred taxes have not been
provided for future taxable distributions from the subsidiary, since it is the Companys
policy not to initiate a distribution of dividends that involves additional tax
liability.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets for future tax benefits are not included where their realization is less than
probable. As such, the Company has recorded a full valuation allowance in regard to all
tax loss carry forwards as well as for other temporary differences (see Note 17F).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. | Impairment
in value of assets
| | -- | -----------------------------

| | The
Company applies Israeli Accounting Standard No. 15  Impairment in Value of Assets
(hereinafter  Standard No. 15). Standard No. 15 provides procedures which a company
must apply in order to ensure that its assets in the consolidated balance sheet (to which
the standard applies), are not presented at an amount which is in excess of their
recoverable value, which is the higher of the net selling price and the use value (the
present value of the estimated future cash flows expected to be derived from use and
disposal of the asset).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard applies to all the assets in the consolidated balance sheet, except inventory,
deferred tax assets and monetary assets. In addition, the standard provides rules for
presentation and disclosure with respect to assets whose value has been impaired. When
the value of an asset in the consolidated balance sheet is higher than its recoverable
value, the Company recognizes a loss from the impairment in value in the amount of the
difference between the book value of the asset and its recoverable value. The loss thus
recognized will be cancelled only in the event of changes occurring in the estimates that
were used to determine the recoverable value of the asset since the date on which the
most recent loss from the impairment in value was recognized.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | N. | Basic
and diluted income (loss) per share
| | -- | -----------------------------------------

| | Until
December 31, 2005, basic profit (loss) per share was computed based on the weighted
average number of Ordinary Shares of nominal NIS 1.00 par value outstanding during each
year, plus the effect of options and warrants outstanding at year-end the exercise of
which is probable. Diluted profit (loss) per share was computed based on the weighted
average number of Ordinary Shares used for computing the basic profit (loss) per share
plus options and warrants which were not included in the basic profit (loss) per share
calculation and which do not have an anti-dilutive effect.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2006 the Company implemented Israeli Accounting Standard No. 21, Earnings
per Share (hereinafter  Standard No. 21) of the Israel Accounting Standards
Board (hereinafter  IASB). In accordance with the provisions of the Standard, the
Company calculates basic earnings or loss per share with respect to earnings or loss, and
basic earnings or loss per share with respect to earnings or loss from continuing
operations, which is attributable to the ordinary shareholders. The basic earnings per
share are calculated by dividing the earnings or loss attributable to the ordinary
shareholders by the weighted average number of ordinary shares outstanding during the
period. In order to calculate the diluted earnings per share, the Company adjusts the
earnings or loss attributable to the ordinary shareholders, and the weighted average
number of outstanding ordinary shares, in respect of the effects of all the dilutive
potential ordinary shares (such as options).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O. | Accounting
for stock-based compensation
| | -- | ---------------------------------------

| | Until
December 31, 2005, the Company recorded expenses with respect to stock options granted to
employees and service providers that provide similar services to those provided by
employees, in accordance with the intrinsic value method described in United States
Accounting Principles Board Opinion No. 25 (APB No. 25) Accounting for Stock Issued
to Employees. Shares issued to service providers were recorded based on the cost of
service provided at the grant date of the shares issued.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2006, the Company adopted Israeli Accounting Standard No. 24, Share-Based
Payments (hereinafter  Standard No. 24) which requires that share-based
payment transactions, including transactions with employees or other parties that are to
be settled by equity instruments, cash or other assets, be recognized in the financial
statements. In accordance with Standard No. 24, share-based payment transactions in which
goods or services are received will be recognized at their fair value. Standard No. 24
applies to share-based payment transactions conducted after March 15, 2005 that have not
yet vested on January 1, 2006. Furthermore, the Standard applies to liabilities deriving
from share-based payment transactions existing on January 1, 2006. Standard No. 24
requires that comparative data relating to periods after March 15, 2005 be restated. As
of December 31, 2005, the charge for equity-settled share-based payments in the
Consolidated Statement of Operations is US$ 7 thousand (see Note 2T).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company records salary expense and an increase in its shareholders equity, over the
vesting periods, based on the fair value of the options on the grant date, using the
Black & Scholes pricing model.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | P. | Other
Assets
| | -- | ------------

| | Other
assets are comprised of costs incurred internally for the development of computer
software intended for sale, lease or marketing which are reported at the lower of
unamortized cost or net realizable value in accordance with the guidelines prescribed by
Statement of Financial Accounting Standard (SFAS) No. 86 Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
Capitalization of software development costs is made upon reaching technological
feasibility and is discontinued when the product is available for sale to customers. In
2006, the Company had technological feasibility and capitalized US$ 292 thousand
development computer software costs as other assets. Capitalized software development
costs are amortized over a period of three years, based on the expected useful life of
the software. Amortization expense for the year ended December 31, 2006 was US$ 73
thousand. In 2004 and 2005, the Company recorded US$ 74 thousand and US$ 296
thousand, respectively as research and development expense in regards to the software
development.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Q. | Concentration
of credit risk
| | -- | ----------------------------

| | Financial
instruments that potentially subject the Company to concentration of credit risk consist
mainly of cash and cash equivalents, restricted bank deposits and trade receivables. At
December 31, 2006 and 2005, the Company had cash and cash equivalents, and restricted
bank deposits which were deposited with major Israeli banks. 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Trade
receivables include amounts billed to customers. Management periodically evaluates the
collectibility of these trade receivables and adjusts the allowance for doubtful accounts
to reflect the amounts estimated to be doubtful of collection.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company operates on the basis of agreements it signs with its customers. As the Company
manages a limited number of projects at the same time, a delay in the execution of a
project may have a material effect on the financial results of any given period. The
majority of the Companys transactions in progress are with major customers, see
Note 19A.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | R. | Fair
value of financial instruments
| | -- | -----------------------------------

| | The
fair market value of the Companys financial instruments, which are cash and cash
equivalents, restricted bank deposits, loan from related party, trade receivables, short
and long-term debt, trade payables, other payables and accrued expenses, and excess of
advances from customers over amounts recognized as revenues approximate their carrying
value as of December 31, 2006 and 2005, due to their short-term nature. The carrying
amounts of the Companys borrowings under its loan agreements approximate their fair
value, since they bear interest that changes according to the LIBOR rate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | S. | Derivative
financial instruments
| | -- | --------------------------------

| | Derivative
financial instruments, held for hedging, are deferred and recognized when the hedged
transactions occur.
| | -------------------------------------------------------------------------------------------------------------------

| | Derivative
financial instruments, not held for hedging, are stated in the financial statements at
their fair value. Changes in fair value are recognized as they occur.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of derivative financial instruments is determined based on their market value
and, when there is no market value, then according to a valuation model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | T. | Change
in accounting principle and reclassification
| | -- | ---------------------------------------------------

| | The
consolidated financial statements as of and for the year ended December 31, 2005, were
restated in order to give retroactive effect to the change in the method of accounting
for share-based payment transactions upon adoption of Standard No. 24 (see Note 2O).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | The
retrospective effect on the Consolidated Statement of Operations is as           follows:
| | --- | ---------------------------------------------------------------------------------------------

| |                         | Year ended December 31, 2005
| | ----------------------- | ----------------------------
|
|
|
|
| | Cost of revenues        |                             
| | Gross profit            |                             
| | Net profit for the year |                             

| | * | Income
taxes in the amount of US$ 60 thousand were classified to cost of revenues in previous
period.
| | - | -----------------------------------------------------------------------------------------------------

| | (2) | The
effect on the consolidated statements of change in Shareholders          Equity is
as follows:
| | --- | ---------------------------------------------------------------------------------------------------

| |                          | December 31, 2005
| | ------------------------ | -----------------
|
|
|
|
| | Addition paid-in capital |                  
| | Accumulated deficit      |                  

| | U. | Disclosure
of effect of new accounting standards in the period prior to their
               implementation
| | -- | -----------------------------------------------------------------------------------------------------------

| | 1. | In
July 2006, the Israel Accounting Standards Board (hereinafter  IASB)
               published Accounting Standard No. 29, Adoption of International
Financial                Reporting Standards (IFRS). The Standard
provides that                entities subject to the Israeli Securities Law  1968
that are required to                report according to the regulations of this law are
to prepare their financial                statements for periods beginning as from
January 1, 2008, according to IFRS. The                Standard permits early adoption
for financial statements published after July                31, 2006.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company will adopt IFRS with effect from January 1, 2008, based upon the guidance of IFRS
1, First Time Adoption of IFRSs. Upon adoption of IFRS in 2008, the Company
will be required to present comparative financial statements as of and for the year ended
December 31, 2007, prepared in accordance with IFRSs. The Company is examining the
effects of the adoption of IFRS, but at this point is unable to evaluate the effect on
its consolidated financial statements. The Company does not intend to implement IFRS
earlier than required.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | U. | Disclosure
of effect of new accounting standards in the period prior to their
               implementation (contd)
| | -- | --------------------------------------------------------------------------------------------------------------------

| | 2. | In
August 2006, the IASB published Accounting Standard No. 26,                Inventory.
The Standard provides guidelines for determining the cost                of inventory and
its subsequent recognition as an expense as well as for                determining
impairment in value of inventory written down to net realizable                value. The
Standard also provides guidelines regarding cost formulas used to                allocate
costs to various types of inventory. The Standard will apply to                financial
statements for periods beginning on January 1, 2007, or thereafter.
               Implementation of the Standard is not anticipated to have a material
effect on                the Companys results of operations and financial position.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
September 2006, the IASB published Accounting Standard No. 27, Fixed
               Assets. The Standard prescribes rules for the presentation,
measurement                and derecognition of property, plant and equipment and for the
disclosure                required in respect thereto. The Standard provides that upon
the initial                recognition of property, plant and equipment, the entity shall
include in the                cost of the item all the costs it will be required to incur
in respect of a                liability to dismantle and remove the asset and to restore
the site on which it                was located. Furthermore, the Standard provides that
a group of similar fixed                assets shall be measured at cost net of
accumulated depreciation, and less                impairment losses, or alternatively, at
its revalued amount less accumulated                depreciation, whereas an increase in
the value of the asset to above its initial                cost as a result of the
revaluation will be directly included in                shareholders equity under a
revaluation reserve. Any part of a fixed asset                with a cost that is
significant in relation to the total cost of the item shall                be depreciated
separately, including the costs of significant periodic                examinations. The
Standard also provides that a fixed asset that was purchased                in
consideration for another non-monetary item in a transaction having a
               commercial substance shall be measured at fair value.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
property, plant and equipment consist of several components with different estimated
useful lives, the individual significant components should be depreciated over their
individual useful lives.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Standard
No. 27 will apply to financial statements for periods beginning on or after January 1,
2007, and will be adopted on a retroactive basis, except for asset retirement obligations
for which initial adoption will be in accordance with the provision of Standard No. 27.
Implementation of the Standard is not anticipated to have any effect on the Companys
results of operations and financial position.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | In
December 2006, the IASB published Accounting Standard No. 23, The
               Accounting Treatment of Transactions between an Entity and its Controlling
               Shareholder. The Standard replaces the Israeli Securities
Regulations                (Financial Statement Presentation of Transactions between a
Company and its                Controlling Shareholder)  1996 and provides that
assets and liabilities                included in a transaction between the entity and
its controlling shareholder                shall be measured on the date of the
transaction at fair value and that the                difference between the fair value
and the consideration from the transaction                shall be included in
shareholders equity. A debit difference is recorded                as a dividend
and, accordingly, reduces retained earnings. A credit difference                is
recorded as an investment of the shareholder and shall, therefore, be
               presented under a separate item of shareholders equity called
               capital reserve from transaction between an entity and its
controlling                shareholder.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | U. | Disclosure
of effect of new accounting standards in the period prior to their
          implementation (contd)
| | -- | ---------------------------------------------------------------------------------------------------------------

| | The
Standard discusses three issues relating to transactions between an entity and its
controlling shareholder, as follows: (1) the transfer of an asset to the entity by the
controlling shareholder, or conversely, transfer of an asset from the entity to the
controlling shareholder; (2) the controlling shareholder assuming upon itself a liability
of the entity to a third party, all or part, indemnification of the entity by the
controlling shareholder in respect of an expense, and the controlling shareholder waiving
the entitys debt to it, all or part; and (3) loans that were granted to the
controlling shareholder or loans that were received from the controlling shareholder. The
Standard also provides the disclosure that is to be made in the financial statements
regarding transactions between the entity and its controlling shareholder during the
period. The Standard shall apply to transactions between an entity and its controlling
shareholder that are executed after January 1, 2007 and to a loan that was granted to a
controlling shareholder or that was received from it before the date this Standard came
into effect as from the date of it coming into effect. In the opinion of the Company,
implementation of the new standard is not anticipated to have a material effect on the
Companys results of operations and financial position.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
March 2007 the IASB published Accounting Standard No. 30, Intangible
               Assets. The Standard explains the accounting treatment of intangible
               assets and defines how to measure the book value of these assets, as well
as the                disclosures that are required. The Standard is implemented
retroactively.  A                research and development asset shall be recognized in the
amount of its value                less the amortization that would have accumulated from
the date of creation                until December 31, 2006 on the basis of the useful
life of the asset, and less                any accrued impairment losses. The amount of
the adjustment shall be included in                the balance of retained earnings of
January 1, 2007.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Implementation
of the Standard is not anticipated to have effect on the Companys results of
operations and financial position.
| | -------------------------------------------------------------------------------------------------------------------------------

# Note 3  Cash and
Cash Equivalents

| |                                                         | December 31
| | ------------------------------------------------------- | -----------
|
|
|
|
| | In U.S. dollars                                         |            
| | In New Israeli Shekels                                  |            
| | In other foreign currencies (Euro and Singapore Dollar) |            
| |                                                         |            
| |                                                         |            
| |                                                         |            
| |                                                         |            

F - 18

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 4  Trade
Receivables

| |                                                 | December 31
| | ----------------------------------------------- | -----------
|
|
|
|
| | Open accounts                                   |            
| | Unbilled revenue *                              |            
| | Receivables from related parties (see Note 20A) |            
| | Receivables from IAI (see Note 16A)             |            
| |                                                 |            
| |                                                 |            
| |                                                 |            
| |                                                 |            

| | * | Unbilled
revenue is comprised as follows:
| | - | -----------------------------------------

| |                                            |  | 
| | ------------------------------------------ |  | 
|
|
|
|
| | Accumulated amounts recognized as revenues |  | 
| | Less - advances from customers             |  | 
| |                                            |  | 
| |                                            |  | 
| | Other income receivable                    |  | 
| |                                            |  | 
| |                                            |  | 
| | Unbilled revenue                           |  | 
| |                                            |  | 

| | Information
on contracts for long-term projects
| | -----------------------------------------------

| |                                               | December 31
2006 and the
year then ended | December 31
2005 and the
year then ended
| | --------------------------------------------- | ---------------------------------------- | ----------------------------------------
|
|
|
|
| | Amount of contracts for long-term projects    |                                          |                                         
| | signed during the year                        |                                          |                                         
| |                                               |                                          |                                         
| |                                               |                                          |                                         
| | Portion of the cumulative amount of contracts |                                          |                                         
| | for long-term projects not yet recognized as  |                                          |                                         
| | income at the year end                        |                                          |                                         
| |                                               |                                          |                                         

F - 19

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 5  Other Receivables
and Prepaid Expenses

| |                                            | December 31
| | ------------------------------------------ | -----------
|
|
|
|
| | Prepaid expenses                           |            
| | Receivables in respect of work in progress |            
| | Loans to employees                         |            
| | Others                                     |            
| |                                            |            
| |                                            |            
| | Less - allowance for doubtful accounts     |            
| |                                            |            
| |                                            |            
| |                                            |            
| |                                            |            

# Note 6  Inventories

| |                                      | December 31
| | ------------------------------------ | -----------
|
|
|
|
| | Finished products                    |            
| | Components for systems manufacturing |            
| | Raw materials                        |            
| |                                      |            
| |                                      |            
| |                                      |            
| |                                      |            

# Note 7  Other
Non-Current Assets

| |                                      | December 31
| | ------------------------------------ | -----------
|
|
|
|
| | Non-current restricted bank deposits |            
| | Non-current prepaid expenses         |            
| |                                      |            
| |                                      |            
| |                                      |            
| |                                      |            

F - 20

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

Note 8  Fixed Assets

| |                                                  | December 31
| | ------------------------------------------------ | -----------
|
|
|
|
| | Computer and electronic equipment                |            
| | Manufacturing equipment                          |            
| | Office equipment                                 |            
| | Leasehold improvements                           |            
| |                                                  |            
| |                                                  |            
| |                                                  |            
| | Less - accumulated depreciation and amortization |            
| |                                                  |            
| |                                                  |            
| | Net book value                                   |            
| |                                                  |            

| | Depreciation
and amortization expense recorded for the years ended December 31, 2006, 2005 and 2004
was US$ 321 thousand, US$ 364 thousand and US$ 690 thousand, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 9  Short-Term
Loan

| | On
October 1, 2003, shareholders of the Company (at that date) granted loans in the total
amount of US$601 thousand, for a period of two years, bearing no interest. On March 2,
2004, loans in the amount of US$ 100 thousand were converted into shares of the Company,
at a price of US$ 0.18 per share. On April 20, 2004, the Company reached an agreement for
the repayment of US$ 204 thousand and a waiver of US$ 177 thousand out of the then
outstanding loan amount.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006 and 2005, a loan in the amount of US$120 thousand is outstanding,
bearing no interest. The Company expects to repay this loan during 2007.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 10  Trade
Payables

| |                                | December 31
| | ------------------------------ | -----------
|
|
|
|
| | Payables to IAI (see Note 16A) |            
| | Open accounts                  |            
| | Sub-contractor payables        |            
| |                                |            
| |                                |            
| |                                |            
| |                                |            

F - 21

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 11  Excess of
Advances from Customers over Amounts Recognized as Revenue

| |                                                 | December 31
| | ----------------------------------------------- | -----------
|
|
|
|
| | Advances from customers                         |            
| | Less - cumulative amounts recognized as revenue |            
| |                                                 |            
| |                                                 |            
| |                                                 |            
| |                                                 |            

# Note 12  Other
Payables and Accrued Expenses

| |                                     | December 31
| | ----------------------------------- | -----------
|
|
|
|
| | Payroll and related accruals        |            
| | Provision for losses and completion |            
| | Government authorities              |            
| | Other accrued expenses              |            
| |                                     |            
| |                                     |            
| |                                     |            
| |                                     |            

# Note 13  Long-Term
Bank Loans

| | A. | Balances
according to linkage basis and rates of interest
| | -- | ---------------------------------------------------------

| |                           | LinkageBasis | Rates ofInterest | December 31
| | ------------------------- | ------------ | ---------------- | -----------
|
|
|
|
| | Long-term bank loans      |              |                  | US dollar  
| | Less - current maturities |              |                  |            
| |                           |              |                  |            
| |                           |              |                 
| |                           |              |                  |            
| |                           |              |                  |            

| | B. | During
the second quarter of 2004, the Company reached an agreement with its
               principal bank to reschedule the repayment of loans in the amount of US$
1,550                thousand, in three equal annual installments for the years 2005,
2006 and 2007.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 14  Liability
for Employee Severance Benefits, Net

| | A. | Under
Israeli law, the Company is required to make severance payments to
               dismissed employees and to employees terminating employment under certain
other                circumstances. The Companys liability for severance pay is
fully provided                for through insurance policies and by accrual.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Due
to a reduction in salaries effective from October 1, 2002 and in accordance with an
agreement between the Company and its employees, the liability for severance pay
calculation is divided into two periods, until the salary reduction and subsequently.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
calculation was based on the number of years of employment until September 30, 2002
multiplied by the latest salary paid as of September, 2002, plus the number of years of
employment commencing October 1, 2002 multiplied by the latest salary paid.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                        | December 31
| | ---------------------- | -----------
|
|
|
|
| | Severance pay          |            
| | Less - amounts funded* |            
| |                        |            
| |                        |            
| |                        |            
| |                        |            

| | *
The Company may only withdraw amounts funded for the purpose of severance pay
disbursement.
| | ---------------------------------------------------------------------------------------------

| | B. | Severance
pay expenses (income) recorded for the years ended December 31, 2006,                2005
and 2004 were US$ 90 thousand, US$ 8 thousand and US$ (78) thousand,
               respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 15 
Shareholders Equity

| | A. | The
Companys ordinary shares are traded in the United States on the Over
               the Counter Bulletin Board (OTCBB) under the symbol BVRSF.OB.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | 
| | -- | 

| |                    | Issued | Outstanding
| | ------------------ | ------ | -----------
|
|
|
|
| | Ordinary shares of |        |            
| | NIS 1.00 par value |        |            
| |                    |        |            

| | The
authorized share capital of the Company as of December 31, 2005 was NIS 200,000,000
divided into 200,000,000 shares.
| | ------------------------------------------------------------------------------------------------------------------------

| | On
July 25, 2006, the shareholders of the Company approved the increase of the authorized
share capital of the Company to NIS 400,000,000, divided into 400,000,000 ordinary shares
par value NIS 1.00 each.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 15 
Shareholders Equity (contd)

| | C. | On
March 1, 2004, and during 2004, the Company completed the issuance of
               66,872,669 shares, in the amount of US$ 11.8 million, of which US$ 9.8
million                was issued in exchange for cash and $2.1 million was issued in
exchange for the                conversion of loans from banks and from a controlling
shareholder.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, Chun (see Note 1B) was granted an option (the Options) to purchase
40,000,000 ordinary shares of the Company, for an additional investment amount of up to
US$7.2 million at an exercise price per share of US$ 0.18, for a period of four years.
The option will expire in March 2008.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Chun
has resolved, and instructed the Company, accordingly, that even though the shareholders
of the Company have voted for the grant of all the options to Chun, Chun shall only be
entitled to 28,531,111 of the options and the remaining 11,468,889 options shall be
distributed as follows: 10,000,000 among the other shareholders of the Company, pro-rata
to the cash invested by them during 2004, and 1,468,889 to the Companys principal
banks.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the third quarter of 2004, Chun exercised 17,666,667 options into shares for the amount
of US$ 3,180 thousand. At December 31, 2006 and 2005, there are 22,333,333 options
outstanding.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | On
March 21, 2006, the Company issued to a group of new investors 20,000,000
               ordinary shares, for a total consideration of $ 3.6 million, together with
three                separate warrants for the purchase of 6,000,000 ordinary shares per
each                warrant, with exercise prices of $ 0.36, $ 0.54 and $ 1.00,
exercisable for a                period of three years, with a mandatory exercise
mechanism under certain                conditions.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | In
January 2004, the Company signed a three-year consulting agreement with Wise
               Pte Ltd. (Wise), a company owned and controlled by the brother
of                Aviv Tzidon, the Companys Chairman of the Board of Directors.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the agreement, Wise will provide the Company marketing services in the Far East, in
consideration of a monthly payment of US$ 3,000 each month by way of issuance of 16,667
of the Companys ordinary shares each month.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
each of the years 2004, 2005 and 2006, the Company issued 200,000 ordinary shares,
totaling 600,000 ordinary shares issued in respect to this agreement.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | On
June 8, 2005, the Company issued to Tact Computers and Systems Ltd.                (Tact)
63,547 ordinary shares of the Company in consideration for                the services
provided by Tact under a service agreement signed on February 2004.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | On
January 1, 2006, the Company signed an expansion to the agreement signed with
               Electra Real-Estate Ltd. (Electra) during August 1999.
According to                the expansion, the Company issued to Electra 1,000,000
ordinary shares of the                Company in consideration for part of the lease
payments for the premises                occupied by the Company.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 15 
Shareholders Equity (contd)

| | H. | Share-based
compensation
| | -- | ------------------------

| | 1. | In
August 2001, the Board of Directors of the Company approved an option plan to
               grant options for the purchase of up to 707,900 ordinary shares to the
               Companys employees, directors and subcontractors. Each option is
               exercisable into one ordinary share of the Company at exercise prices of
US$                0.90  US$ 2.69, equal to the market price of the share on the
date of                issuance.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforesaid options are exercisable in two increments, one third after one year from the
date of issuance and two thirds after two years from the date of issuance. The options
will expire after three years from the vesting date of each increment. At December 31,
2006, there are 32,600 options outstanding under this plan. No other options are
available for additional grants under this plan.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2004, the Company granted Aviv Tzidon, the Chairman of the Board of
               Directors, an option to purchase 9,000,000 ordinary shares of the Company
vested                in five equal increments subject to him serving as an active
Chairman of the                Board of Directors. The exercise price per share shall be
US$ 0.18. The options                will expire after three years from the vesting date
of each installment. As at                December 31, 2006, there are 9,000,000 options
outstanding, 5,400,000 of which                are exercisable.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
the same date, the Company also granted to each of the Companys directors (not
including Aviv Tzidon), options to purchase 72,000 shares of the Company (total of
648,000 shares), at an exercise per share of US$ 0.18. The options were subject to the
completion of a full year of service. As at December 31, 2006, there are 576,000
options outstanding and exercisable, after the cancellation of 72,000 options of one
director who did not complete a full year of service.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
January 2004, the Companys Board of Directors approved the grant of up
               to 5,000,000 options to the Companys employees and service
providers. In                2006, the Companys Board of Directors approved an
increase to the total                option program to 5,200,000 options. Each option is
exercisable into one                ordinary share of the Company. At December 31, 2006,
there are 3,924,000 options                outstanding for employees and there are
1,064,000 options outstanding for                service providers, 1,661,600 and 586,000
of which are exercisable for employees                and service providers,
respectively. As of December 31, 2005, there were                3,657,000 options
outstanding for employees, of which 83,000 options were                cancelled during
2006.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
options are exercisable at prices of US$ 0.145 to US$ 0.65 per share, and are exercisable
in five equal increments commencing one year after their issuance. The options will
expire after three years from the vesting date of each increment.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
cost of the benefit inherent in the options based on the fair value on the day of their
grant in accordance with the provisions of Standard No. 24 of the Israel Accounting
Standards Board (see Note 2O) amounts to approximately US$ 68 and US$ 29 thousand for
2006 and 2005, respectively. This amount will be recognized as an expense over the
vesting period of each portion. An expense in the amount of US$ 31 thousand and US$ 7
thousand was recorded in 2006 and 2005, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 15 
Shareholders Equity (contd)

| | H. | Share-based
compensation (contd)
| | -- | ---------------------------------

| | 4. | Data
in respect of the option plans
| | -- | -----------------------------------

| | a. | A
summary of the status of the Companys stock option plans as of December
               31, 2006, 2005 and 2004, and changes during the years then ended, is as
follows:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                | As of December 31,
| | -------------- | ------------------
|
|
|
|
| | Options        |                   
| | outstanding at |                   
| | the beginning  |                   
| | of the year    |                   
| | Granted        |                   
| | Forfeited      |                   
| |                |                   
| | Outstanding at |                   
| | the end of     |                   
| | the year       |                   
| |                |                   
| | Options        |                   
| | exercisable at |                   
| | year-end       |                   
| |                |                   

| | b. | The
following table summarizes information relating to stock options at December
          31, 2006:
| | -- | ----------------------------------------------------------------------------------------------------

| |                      | Number of Options
| | -------------------- | -----------------
|
|
|
|
| | Exercise price (US$) |                  
| |                      |                  
| | 2.69                 |                  
| | 2.06                 |                  
| | 0.9                  |                  
| | 0.65                 |                  
| | 0.55                 |                  
| | 0.23                 |                  
| | 0.185                |                  
| | 0.18                 |                  
| | 0.17                 |                  
| | 0.145                |                  
| |                      |                  
| |                      |                  
| |                      |                  
| |                      |                  

F - 26

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 15 
Shareholders Equity (contd)

| | H. | Share-based
compensation (contd)
| | -- | ---------------------------------

| | 4. | Data
in respect of the option plans (contd)
| | -- | --------------------------------------------

| | c. | Outstanding
options as at December 31, 2006 may be exercised as follows:
| | -- | ------------------------------------------------------------------------

| |                           | Number
of options | Weighted
average
exercise
price (US$)
| | ------------------------- | ----------------- | -------------------------------------
|
|
|
|
| | Immediately               |                   |                                      
| | First year                |                   |                                      
| | Second year or thereafter |                   |                                      
| |                           |                   |                                      
| |                           |                   |                                      
| |                           |                   |                                      
| |                           |                   |                                      

| | d. | The
fair value of the options granted and accounted for under Standard No. 24
               was calculated on the basis of the Black & Scholes model for the
pricing of                options. The parameters that were used in order to implement
the model are as                follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                     | Option Granting date
| | ------------------- | --------------------
|
|
|
|
| | Share price(in US$) |                     
| | Exercise price      |                     
| | (in US$)            |                     
| | Expected volatility |                     
| | Life of options     |                     
| | (in years)          |                     
| | Risk-free           |                     
| | interest rate       |                     
| | Rate of anticipated |                     
| | dividends           |                     

| | The
expected volatility was determined on the basis of the historical volatility in the
Companys share prices.
| | ---------------------------------------------------------------------------------------------------------------

| | The
life of the option warrants was determined on the basis of the managements estimate
of the period the employees will hold the options, taking into consideration their
position with the Company and the Companys experience regarding the turnover of
employees.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
risk-free interest was determined on the basis of the yield to maturity of
US$-denominated Government debentures with a remaining life equal to the anticipated life
of the option warrants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 16 
Commitments and Contingent Liabilities

| | A. | Cooperation
agreement
| | -- | ---------------------

| | The
Company developed, manufactured and marketed the Ehud system pursuant to a
joint venture agreement entered into in 1992 with the MLM division of Israel Aircraft
Industries Ltd. (the IAI Agreement). Pursuant to the IAI Agreement, the
Company and IAI agreed to jointly develop, manufacture and market the Ehud,
with IAI subcontracting certain of the manufacturing and integration work with respect to
the Ehud product to the Company. The IAI Agreement expired pursuant to its
terms in October 1997.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
August 1999, the Company signed a new agreement with IAI (the 1999 Agreement)
which governs the cooperation between the parties and which also provides guidelines for
fair competition between the parties, this without adversely impacting existing
agreements previously signed with third parties.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
parties have agreed that the Ehud system will be marketed by each of the
parties, in various territories, in consideration of the payment of various royalties to
the other party.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the 1999 Agreement, the following worldwide territories have been delineated:
| | ----------------------------------------------------------------------------------------

| | 1. | A
territory in which one party operates exclusively requires payment of
               royalties to the other party at the rate of 4.75%  12.5% of the
contract                consideration with respect to contracts executed in such
countries until 2008.                The party receiving the royalty shall not operate in
this territory in any                manner whatsoever.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | A
territory in which the parties may compete, the selling party is required to
               pay the other party royalties at the rate of 4%-8% of the contract
               consideration, with respect to contracts executed in such countries until
2008.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Countries
not included in a. and b., above, shall be covered by a separate
               arrangement.
| | -- | ------------------------------------------------------------------------------------------------------

| | The
agreement, whose terms are set forth above, apply to the sale of the Ehudsystems.
With regard to other product, separate royalty payment arrangements were set up.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
August 11, 2005, the Company and IAI signed a new agreement (the 2005 Agreement)
which continues and expands the 1999 Agreement. The 2005 Agreement expands cooperation
between the parties in the marketing of Naval Combat Maneuvering Instrumentation Systems
in various countries worldwide through the transfer of work share from the leading party
to the other. The 2005 Agreement also sets the rate of royalties in all territories to 5%
with respect to Ehud Systems. In addition, the 2005 Agreement resolved all
disagreements between the parties prior to January 1, 2005. The term of the 2005
Agreement is for 10 years. As result of the resolution of the disagreements between the
parties, the Company released during 2005, certain previously accrued liabilities in the
amount of $780 thousand that are no longer payable as a result of the new agreement
signed with IAI in 2005, this amount was credited to the cost of revenues during 2005. In
2006 and 2005, the Company recognized royalty revenue from IAI in the amount of US$ 0.3
million and US$ 1.7 million, respectively. Furthermore, the Company recorded royalty fees
to IAI in the amount of US$ 0.2 million and US$ 0.3 million for the years ended December
31, 2006 and 2005, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 16 
Commitments and Contingent Liabilities (contd)

| | B. | Lease
commitments
| | -- | -----------------

| | The
premises occupied by the Company are rented under various operating leases expiring at
the end of September 2009. The future minimum annual rental payments as of December 31,
2006 are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year ending December 31, | US$ thousand
| | ------------------------ | ------------
|
|
|
|
| | 2007                     |             
| | 2008                     |             
| | 2009                     |             
| |                          |             
| |                          |             
| |                          |             
| |                          |             

| | C. | Spin-off
| | -- | --------

| | In
connection with the 1998 spin-off (see Note 1) the Company and BVR Tech entered into
several agreements for the purpose of giving effect to the spin-off and defining the
Companys and BVR Techs working relationship, as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | The
Company and BVR Tech each undertook to indemnify and/or compensate the other
               (the Injured Party) for any amount, damage or expense that the
               Injured Party incurs in consequence of a third-party claim relating to a
field                of activity of the indemnifying party, concerning events occurring
before the                effective date of the spin-off, provided that the Injured Party
notified the                indemnifying party of the third-party claim and allowed the
indemnifying party                to manage and defend such claim. As of December 31,
2006, the Company has no                information that would indicate that any material
payments will be required in                respect of this agreement.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company and BVR Tech entered into an agreement concerning technology
               transfers and cross licenses between each of the parties. Under this
agreement,                BVR Tech transferred to the Company the rights to co-ownership
of BVR                Techs intellectual property as related to the defense-related
operations                transferred to the Company pursuant to the spin-off agreement.
In January                2003, the Company and BVR Tech entered into a Technology
Transfer and Assignment                Agreement pursuant to which the Company purchased
from BVR Tech all rights,                title and interest to all patents that were in
the co-ownership of the parties,                in consideration for US$12 thousand.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | BVR
Tech will only be entitled to exploit such intellectual property rights for
               its activities that do not conflict with the Companys activities as
               conducted at the time of consummation of the spin off plan other than with
               respect to applications relating to simulation and training systems for
               commercial applications which shall be exploited solely by the Company.
The                Company and BVR Tech further agreed not to compete with each others
               business activities.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 16 
Commitments and Contingent Liabilities (contd)

| | D. | Liabilities
and guarantees
| | -- | --------------------------

| | 1. | In
order to provide security for the credit received from banks and for the bank
               guarantees provided in favor of the Company, the Company registered first
degree                fixed and floating liens on money deposits, a floating lien on all
its property,                assets and related insurance benefits and a floating lien on
its unpaid share                capital, its goodwill and its plant, assets and rights.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
certain occasions the Company deposits cash and cash equivalents with certain
               financial institutions that have issued guarantees on behalf of the
Company in                favor of its customers. In order to fulfill the above-mentioned
commitments, the                Company places a charge on its bank deposits (including
the insurance rights                attached thereto). At December 31, 2006, there are US$ 2,054
thousand in                current and non-current restricted bank deposits (as at
December 31, 2005                US$ 2,364 thousand current and non-current
restricted bank deposits).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Guarantees
issued by banks in favor of the Company are as follows:
| | -- | ------------------------------------------------------------------

| |                            | December 31
| | -------------------------- | -----------
|
|
|
|
| | Performance guarantees     |            
| |                            |            
| |                            |            
| | Advance payment guarantees |            
| |                            |            
| |                            |            
| | Other bank guarantees      |            
| |                            |            

| | The
expiration dates of the guarantees are up to October 31, 2012. Bank charges on those
guarantees are attributed to financial expenses.
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | E. | Derivative
financial instruments
| | -- | --------------------------------

| | The
Company enters, from time to time, into foreign currency future contracts and put and
call options contracts to reduce the impact of fluctuations of certain currencies against
the U.S. dollar resulting primarily from firm commitments not denominated in U.S.
dollars. Gains or losses resulting from qualified hedges of firm commitments are deferred
and recognized when the hedged transactions occur, while results of transactions which do
not meet all the criteria specified in SFAS No. 52 and SFAS No. 80 are recorded as
financial income or expense.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | In
November 2006, the Board of directors approved the new service agreement
               signed with Wise (see Note 15E) effective as of January 1, 2007. According
to                the agreement, Wise will provide marketing and support services in
Singapore in                exchange for a gross monthly fee of US$ 3,500 for marketing
services and a gross                monthly fee of US$ 3,500 for the support services. In
the event that during the                term of the new agreement, the Company shall
receive a purchase order for its                products or services based on the
marketing services, Wise shall be entitled to                a commission as follows: (a)
on the first US$ 1,000,000 received from a purchase                order a commission
equal to 3%; (b) on amounts between US$ 1,000,000 and up to                US$ 3,000,000
 a commission equal to 2%; (c) on amounts over US$                3,000,000-a
commission equal to 1%.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
new agreement is for a period of two years from the effective date.
| | -----------------------------------------------------------------------

F - 30

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 17  Income
Taxes

| | A. | Tax
benefits under the Israeli Law for the Encouragement of Industry (Taxes),           1969
| | -- | --------------------------------------------------------------------------------------------

| | The
Company is an industrial company, as defined by this law and, as such, is
entitled to certain tax benefits, mainly accelerated depreciation of machinery and
equipment, as prescribed by regulations published under the Israeli Income Tax
(Inflationary Adjustments) Law, 1985 (see Note 17C), the right to claim public issuance
expenses and amortization of patents and other intangible property rights as a deduction
for tax purposes.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Tax
benefits under the Israeli law for the Encouragement of Capital           Investments,
1959 (the law)
| | -- | -----------------------------------------------------------------------------------------------------------

| | Pursuant
to the law, the Company was awarded Approved enterprise status under the
government alternative benefits track. The main benefits to which the Company will be
entitled is to a full exemption on its taxable income arising from the second and third
plan for a period of two years and a reduced tax rate of 25% for an additional five years
from the date on which the investments are significantly completed and the Company has
taxable income as defined by the law.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
benefits, to which the Company will be entitled, will be granted on the proportionate
part of the income, deriving from a future increase in its income in excess of the base
turnover, which is not entitled to benefits. The utilization of the seven years of
benefits for the second and third plans is limited to 2012 and 2016, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
1998, the Company applied for approval of the expansion of its facilities in Rosh Haayin
(the second plan).
| | -----------------------------------------------------------------------------------------------------------------

| | In
addition, in 2001 the Company filed a request for an additional new plan to expand its
production facilities in Rosh Haayin (the third plan). The request was
approved in 2002.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, due to losses, the Company had not yet utilized the tax benefits
provided in the second and third plans.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | The
Companys Board of Directors has determined that such tax-exempt income will not be
distributed as dividends. Accordingly, no deferred income taxes have been provided on
income attributable to the Companys Approved Enterprise.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the retained tax-exempt income is distributed in a manner other than the complete
liquidation of the Company, it would be taxed at the corporate tax rate applicable to
such profits as if the Company had not chosen the alternative tax benefits (currently
25%). As of December 31, 2006, the Company has accumulated losses (see Note 17I).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforementioned benefits are conditional upon compliance with the terms and regulations as
prescribed by law, and the approvals according to which the investments were carried out.
Non-compliance with the terms may result in the cancellation of the benefits, in whole,
or in part, and the refund of the benefit amounts in addition to accrued interest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Companys management is of the opinion that it is in
compliance with all of the aforementioned terms.
| | ----------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 17  Income
Taxes (contd)

| | C. | Measurement
of taxable income under the Income Tax (Inflationary Adjustments)                Law, 1985
(TheInflationary Adjustments Law)
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the Inflationary Adjustments Law, results for tax proposes are measured in real term,
taking into consideration the change in the Israeli Consumer Price Index (CPI).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Tax
rates applicable to income from other sources in Israel
| | -- | -----------------------------------------------------------

| | Income
derived from sources other than the Approved Enterprise is not eligible for the
aforementioned benefits and is taxed at the regular rate of 31%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | On
June 29, 2004, the Knesset passed the Israeli Law for the Amendment of
               the Income Tax Ordinance (Amendment No. 140 and Temporary Order)                2004 (hereinafter
 Amendment 140). Amendment 140 provides for a                gradual reduction in
the company tax rate from 36% to 30% in the following                manner: in 2004 the
tax rate will be 35%, in 2005  34%, in 2006  32%                and from 2007
onward the tax will be 30%.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
July 25, 2005, the Knesset passed the Israeli Law for the Amendment of
               the Income Tax Ordinance (No.147 and Temporary Order)  2005               (hereinafter
 the Amendment). The Amendment provides for a gradual                reduction in
the company tax rate in the following manner: in 2006 the tax rate                will be
31%, in 2007  29%, in 2008  27%, in 2009 - 26% and
               from 2010 onward 25%. Furthermore, as from 2010, upon reduction of the
company                tax rate to 25%, real capital gains will be subject to tax of 25%.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Taxation
of foreign subsidiary
| | -- | ------------------------------

| | The
Companys subsidiary in the Far East is taxed under the tax laws in force in that
country.
| | ----------------------------------------------------------------------------------------------

| | F. | Deferred
income taxes
| | -- | ---------------------

| | Deferred
income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets for future tax benefits from realization are included where their realization
is probable. As such, the Company has recorded a valuation allowance in regard of all its
tax losses carried forward as well as for other temporary differences.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 17  Income
Taxes (contd)

| | F. | Deferred
income taxes (contd)
| | -- | ------------------------------

| | Significant
components of the Companys deferred tax liabilities and assets are as follows:
| | -------------------------------------------------------------------------------------------

| |                                                | December 31
| | ---------------------------------------------- | -----------
|
|
|
|
| | Deferred tax assets:                           |            
| | Provision for vacation                         |            
| | Liability for employees severance benefit, net |            
| | Net operating loss carryforwards               |            
| | Research and development costs, net            |            
| | Issuance expenses                              |            
| | Capitalized software expenses                  |            
| | Others                                         |            
| |                                                |            
| |                                                |            
| | Less: Valuation allowance                      |            
| |                                                |            
| | Deferred tax asset                             |            
| |                                                |            

| | The
Company recognized deferred taxes based on a tax rate of 25% according to the tax rate
anticipated to be in effect on the date of reversal as stated in Note 17D above.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company has not provided for deferred income taxes on the
undistributed earnings of approximately US$ 190 thousand of it foreign subsidiary in
Singapore since these earnings are intended to be reinvested indefinitely. A deferred tax
liability will be recognized when the Company no longer demonstrates that it plans to
permanently reinvest the undistributed earnings. The Company estimated that additional
taxes of approximately US$ 47.5 thousand will be payable when these earnings are
remitted.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | A
reconciliation of the theoretical tax expense, assuming all income is taxable
               at the statutory rates applicable in Israel, and the actual tax expense,
is as                follows:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                               | Year ended December 31
| | --------------------------------------------- | ----------------------
|
|
|
|
| | Profit (loss) before taxes on income          |                       
| |                                               |                       
| | Statutory tax rate in Israel                  |                       
| |                                               |                       
| | Theoretical tax cost (benefit)                |                       
| | Losses, deductions and expenses in respect of |                       
| | which deferred tax assets were not recorded   |                       
| | Taxes in respect of previous years            |                       
| | Non-deductible expenses                       |                       
| |                                               |                       
| | Actual tax expense                            |                       
| |                                               |                       

| | (1) | Reclassified
| | --- | ------------

F - 33

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 17  Income
Taxes (contd)

| | H. | Income
tax assessments
| | -- | ----------------------

| | During
2005, the Company reached an agreement with the Israeli Tax Authorities which finalized
the income tax assessments of the 1998-2000 tax years. According to the agreement the
Company should pay the tax authorities $1.3 million, including interest in 36 monthly
payments commencing April 2005 up to March 2008.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Net
operating losses carryforwards
| | -- | ----------------------------------

| | Net
operating loss carryforwards as of December 31, 2006, totaled approximately US$ 47
million. The net operating loss carryforwards have no expiration date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 18  Monetary
balances in Currencies Other than the US Dollar

| |                       | December 31, 2006 | December 31, 2005
| | --------------------- | ----------------- | -----------------
|
|
|
|
| | Assets                |                   |                  
| | Current assets        |                   |                  
| |                       |                   |                  
| | Total assets          |                   |                  
| |                       |                   |                  
| |                       |                   |                  
| | Liabilities           |                   |                  
| | Current liabilities   |                   |                  
| | Long-term liabilities |                   |                  
| |                       |                   |                  
| | Total liabilities     |                   |                  
| |                       |                   |                  

F - 34

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 19 
Supplementary Statement of Operation Information

| | A. | Summary
information about geographical areas:
| | -- | ---------------------------------------------

| | Total
revenues are attributed to geographic areas based on the location of the customers.
| | -----------------------------------------------------------------------------------------

| |                                   | Year ended December 31
| | --------------------------------- | ----------------------
|
|
|
|
| | Total revenues from:              |                       
| | Israel                            |                       
| | Far East                          |                       
| | Europe                            |                       
| | Africa                            |                       
| | America                           |                       
| |                                   |                       
| |                                   |                       
| |                                   |                       
| |                                   |                       
| |                                   |                       
| | Major customers data as a         |                       
| | percentage of the total revenues: |                       
| |                                   |                       
| | Customer A                        |                       
| | Customer B                        |                       
| | Customer C                        |                       
| | Customer D                        |                       
| | Customer E                        |                       
| | Customer F                        |                       
| | Customer G                        |                       
| |                                   |                       
| |                                   |                       
| |                                   |                       
| |                                   |                       

| | * | Less
than 10%.
| | - | --------------

| | B. | Cost
of revenues
| | -- | ----------------

| |                                         | Year ended December 31
| | --------------------------------------- | ----------------------
|
|
|
|
| | Raw materials and components            |                       
| | Salaries, wages and employees' benefits |                       
| | Subcontractors                          |                       
| | Agents fees                             |                       
| | Depreciation                            |                       
| | Other manufacturing costs               |                       
| |                                         |                       
| |                                         |                       
| |                                         |                       
| |                                         |                       

| | * | Restated
(see Note 2T)
| | - | ----------------------

| | (1) | Reclassified
| | --- | ------------

F - 35

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 19 
Supplementary Statement of Operation Information (contd)

| | C. | Financial
expenses, net
| | -- | -----------------------

| |                                               | Year ended December 31
| | --------------------------------------------- | ----------------------
|
|
|
|
| | Financial income:                             |                       
| | Interest on short-term deposits               |                       
| | Interest on loans to others and interest from |                       
| | non-current receivables                       |                       
| | Other                                         |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| | Financial expenses:                           |                       
| | Bank charges and interest on long-term loan   |                       
| | Other                                         |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| | Total financial expenses, net                 |                       
| |                                               |                       

| | D. | Other
income (expenses), net
| | -- | ----------------------------

| |                                       | Year ended December 31
| | ------------------------------------- | ----------------------
|
|
|
|
| | Gain on waiver of long-term loan from |                       
| | former related party                  |                       
| | Others                                |                       
| |                                       |                       
| |                                       |                       
| |                                       |                       
| |                                       |                       

| | E. | Other
| | -- | -----

| |                    | Year ended December 31
| | ------------------ | ----------------------
|
|
|
|
| | Rent costs         |                       
| |                    |                       
| |                    |                       
| | Advertising costs  |                       
| |                    |                       
| |                    |                       
| | Royalties expenses |                       
| |                    |                       

F - 36

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 20  Related
Parties

| | A. | Balances
| | -- | --------

| | Related
parties are comprised of principal shareholders (holding 10% or greater of the Companys
share capital) and their subsidiaries and affiliates as well as affiliates of the
Company. Transactions with related parties are mainly as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Sales
of the Companys products, and expenses related to such sales.
| | -- | --------------------------------------------------------------------

| | 2. | Interest
payable on loans received.
| | -- | -----------------------------------

| | 3. | Payment
of management fees.
| | -- | ---------------------------

| | 4. | Purchases
of services and products.
| | -- | -----------------------------------

| | All
transactions and terms with related parties were comparable to those applied to
transactions with other customers or suppliers.
| | -----------------------------------------------------------------------------------------------------------------------------------

| |                           |   |                                            | December 31
| | ------------------------- | - | ------------------------------------------ | -----------
|
|
|
|
| | Due from:                 |   |                                            |            
| | Cash and cash equivalents | - | Bank Leumi Ltd.                            | 1,516      
| | Restricted bank deposits  | - | Bank Leumi Ltd.                            | 707        
| |                          
| | Trade receivables         | - | ST Training and Simulation Pte Ltd.        | 51         
| |                          
| | Other receivables         | - | Bank Leumi Ltd.                            | 8          
| |                           |   | Prescient Systems and Technologies Pte Ltd | 30         
| |                          
| | Other Non-current assets  | - | Bank Leumi Ltd.                            | 169        
| |                          
| | Due to:                   |   |                                            |            
| | Short-term bank credit    | - | Bank Leumi Ltd.                            | 229        
| |                          
| | Other payable             | - | Bank Leumi Ltd.                            | 4          
| |                           |   | Prescient Systems and Technologies Pte Ltd | 40         
| |                           |   | ST Training and Simulation Pte Ltd.        | 360        
| |                          
| | Long-term loan            | - | Bank Leumi Ltd.                            | -          

| | B. | Transactions
with related parties
| | -- | ---------------------------------

| |                                         | Year ended December 31
| | --------------------------------------- | ----------------------
|
|
|
|
| | Sales (1)                               |                       
| | Cost of sales (1) (2) (5)               |                       
| | Marketing expenses (2) (5)              |                       
| | General and administrative expenses (4) |                       
| | Finance expenses, net (3)               |                       
| | Other income (5)                        |                       

| | (1) | To
ST Training and Simulation Pte Ltd.
| | --- | --------------------------------------

| | (2) | To
Prescient Systems and Technologies Pte Ltd.
| | --- | ----------------------------------------------

| | (3) | To
Bank Leumi
| | --- | -------------

| | (4) | Including
the salary of the CEO and fees paid to directors.
| | --- | -----------------------------------------------------------

| | (5) | From
Aeronautics
| | --- | ----------------

F - 37

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

# Note 21 
Differences between Israeli GAAP and U.S. GAAP

| | A. | The
effect of the differences between Israeli GAAP and US GAAP on the           financial
statements
| | -- | ----------------------------------------------------------------------------------------------------

| | As
discussed in Note 2, the accompanying consolidated financial statements were prepared in
accordance with Israeli generally accepted accounting principles (Israeli GAAP),
which differ in certain respects from those generally accepted in the United States of
America (U.S. GAAP). Information related to the nature and effect of such
differences is presented below.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Reconciliation
of:
| | -- | ------------------

| | a. | Israeli
GAAP net income to net income according to U.S. GAAP:
| | -- | -------------------------------------------------------------

| |                                                         | Year ended December 31
| | ------------------------------------------------------- | ----------------------
|
|
|
|
| | Net profit (loss) as reported, according to             |                       
| | Israeli GAAP                                            |                       
| | GAAP differences:                                       |                       
| | Reversal of restatement according to Standard           |                       
| | No. 24 (see Note 2T)                                    |                       
| | Allocation of share expense issued to service providers |                       
| | under the fair value based method                       |                       
| | Compensation expense for all stock-based awards         |                       
| | using the modified prospective method                   |                       
| | (see Note 21C(2))                                       |                       
| |                                                         |                       
| | Net profit (loss) according to U.S. GAAP                |                       
| |                                                         |                       
| |                                                         |                       
| | I.      Basic and diluted net profit (loss) per         |                       
| | share                                                   |                       
| | As reported, according to Israeli GAAP                  |                       
| |                                                         |                       
| | According to U.S. GAAP                                  |                       
| |                                                         |                       
| |                                                         |                       
| | II.     Weighted average number of ordinary             |                       
| | shares outstanding (in thousands)                       |                       
| | used in basic profit (loss) per share                   |                       
| | calculation according to U.S. GAAP                      |                       
| |                                                         |                       
| |                                                         |                       
| | Weighted average number of ordinary                     |                       
| | shares outstanding (in thousands)                       |                       
| | used in diluted profit (loss) per share                 |                       
| | calculation according to U.S. GAAP                      |                       
| |                                                         |                       

* Restated (See Note 2T)** Restated (see Note 21B).

F - 38

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

Note 21  Differences between
Israeli GAAP and U.S. GAAP (contd)

| | A. | The
effect of the differences between Israeli GAAP and US GAAP on the           financial
statements (contd)
| | -- | -------------------------------------------------------------------------------------------------------------

| | 1. | Reconciliation
of (contd):
| | -- | ---------------------------

| | b. | Shareholders equity
according to US GAAP:
| | -- | ------------------------------------------

| |                                  | Share capital |  |  |             | 
| | -------------------------------- | ------------- |  |  | ----------- | 
|
|
|
|
| | Balance as of January 1, 2004    |               |  |  | 10,660,874  | 
| |                                  |               |  |  |             | 
| |                                  |               | 
| | Net loss for the year            |               |  |  | -           | 
| | Issuance of shares and options   |               |  |  | 66,872,669  | 
| | Issuance of shares in respect of |               | 
| | services                         |               |  |  | 200,000     | 
| | Exercise of stock options        |               |  |  | 17,666,667  | 
| | Stock-based compensation**       |               |  |  | -           | 
| |                                  |               |  |  |             | 
| |                                  |               | 
| | Balance as of December 31, 2004  |               |  |  | 95,400,210  | 
| |                                  |               | 
| | Net profit for the year          |               |  |  | -           | 
| | Issuance of shares               |               | 
| | in respect of services           |               |  |  | 263,547     | 
| | Stock-based compensation**       |               |  |  | -           | 
| |                                  |               |  |  |             | 
| |                                  |               | 
| | Balance as of December 31, 2005  |               |  |  | 95,663,757  | 
| |                                  |               | 
| | Net loss for the year            |               |  |  | -           | 
| | Issuance of shares and warrants  |               |  |  | 20,000,000  | 
| | Issuance of shares               |               | 
| | in respect of services           |               |  |  | 1,200,000   | 
| | Stock-based compensation         |               |  |  | -           | 
| |                                  |               |  |  |             | 
| |                                  |               | 
| | Balance as of December 31, 2006  |               |  |  | 116,863,757 | 
| |                                  |               |  |  |             | 

| | ** | Restated
(See Note 21B).
| | -- | ------------------------

| | 2. | Condensed
balance sheet items
| | -- | -----------------------------

| |                            | December 31
| | -------------------------- | -----------
|
|
|
|
| | Severance pay fund         |            
| |                            |            
| | Total assets               |            
| |                            |            
| | Liability for employee     |            
| | severance benefits, net    |            
| |                            |            
| | Total liabilities          |            
| |                            |            
| | Total shareholders' equity |            
| |                            |            

F - 39

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

Note 21  Differences between
Israeli GAAP and U.S. GAAP (contd)

| | B. | Restatement
| | -- | -----------

| | The
statements of operations in accordance with U.S. GAAP for the years ended December 31,
2004 and 2005 have been restated in order to reflect a correction in 2004 and 2005,
relating to compensation expense to certain service providers which should have been
treated as employees. In accordance with APB No. 25, in the years 2004 and 2005 no
compensation expense should have been recorded in respect to these service providers, who
should have been treated as employees.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                             | Year ended December 31
| | ----------------------------------------------------------- | ----------------------
|
|
|
|
| | Non-employee stock option expenses under the                |                       
| | fair value method - as reported                             |                       
| | Non-employee stock option expenses under the                |                       
| | fair value method - as restated                             |                       
| | Net loss according to US GAAP - as reported                 |                       
| | Net profit (loss) according to US GAAP - as restated        |                       
| | Basic and diluted net loss per share - as reported          |                       
| | Basic and diluted net profit (loss) per share - as restated |                       

| | C. | Accounting
principles generally accepted in Israel compared to accounting                principles
generally acceptedin the United States
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Liability
for termination of employer-employee relations
| | -- | --------------------------------------------------------

| | According
to Israeli GAAP
| | -------------------------

| | Amounts
funded by purchase of insurance policies are deducted from the related severance pay
liability.
| | -------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP
| | ----------------------

| | According
to U.S. GAAP, the amounts funded should be presented as long-term investments and the
gross amount of the liability should be presented as a long-term liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Stock
options granted to employees, service providers and other non-employees
               and stock issued toservice providers
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

| | According
to Israeli GAAP
| | -------------------------

| | Until
December 31, 2005, the Company recorded expenses with respect to stock options granted to
employees and service providers that provide similar services to those provided by
employees, in accordance with the intrinsic value method described in APB 25 Accounting
for Stock Issued to Employees. Shares issued to service providers were recorded
based on the cost of service at the grant date of the shares issued.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2006, the Company applies Standard No. 24 and records expense for
share-based payment transactions conducted after March 15, 2005 and not yet vested at
January 1, 2006, the expenses recorded in accordance with the fair value of the options
on the grant date using the Black & Scholes model.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



|B.V.R. Systems (1998) Ltd.                    
|----------------------------------------------
|                                              
|Notes to the Consolidated Financial Statements
|                                              

Note 21  Differences between
Israeli GAAP and U.S. GAAP (contd)

| | C. | Accounting
principles generally accepted in Israel compared to accounting                principles
generally acceptedin the United States (contd)
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Stock
options granted to employees, service providers and other non-employees
               and stock issued toservice providers (contd)
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP
| | ----------------------

| | Stock
options granted to employees
| | ----------------------------------

| | Prior
to fiscal 2006, the Company applied the intrinsic value method as prescribed in APB No. 25,
and related interpretations, in accounting for stock options granted under the stock
option plan. Under the intrinsic value method, no compensation cost is recognized if the
exercise price of the Companys employee stock options was equal to or greater than
the market price of the underlying stock on the date of the grant. Accordingly, no
compensation cost was recognized in the accompanying consolidated statements of operation
prior to fiscal year 2006 on stock options granted to employees, since all options
granted under the Companys stock option plan had an exercise price equal to the
market value of the underlying common stock on the date of grant.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based
Payments) (SFAS 12SR) using the modified prospective method, which requires
measurement of compensation cost for all stock-based awards based upon the fair value on
the date of grant and recognition of such compensation cost over the service period for
awards expected to vest. Under this method, the Company recognizes compensation cost for
awards granted on or after January 1, 2006, based on the Black-Scholes option-pricing
model. In addition, the Company recognizes compensation cost for unvested share-based
awards as of January 1, 2006 based on the grand date fair value of those awards, as
previously calculated and reported for pro-forma disclosure purposes, over the requisite
service period of the awards.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Stock
warrants granted to service providers and other non-employees and stock issued to service providers
| | ---------------------------------------------------------------------------------------------------------

| | The
Company accounts for such awards in accordance with the provisions of EITF 96-18, Accounting
for Equity Instruments That are Issued to Other than employees for Acquiring, or in
conjunction of Selling, Goods or Services. Since the warrants issued by the Company
are not fully vested, and no performance commitment as defined in EITF 96-18 has been
reached, the Company estimates the cost of the unvested warrants based on the fair value
of the warrants at each reporting period (using the Black & Scholes model) and
accounts for the portion of the services that the recipient has rendered to date using
that estimate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---