UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549


FORM
20-F




(Mark
One)




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




OR




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


For the
fiscal year ended December 31, 2008




OR




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


For the
transition period from __________ to __________




OR




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


Date of event requiring this shell
company report ________




Commission
file number 1-14426




BLUE
SQUARE-ISRAEL LTD.





(Exact
name of Registrant as specified in its charter)




Israel





(Jurisdiction
of incorporation or organization)




2 Amal
Street, Rosh Ha’ayin 48092, Israel





(Address
of principal executive offices)


Elli
Levinson-Sela, General Counsel & Corporate Secretary;


Tel:
(972)-3-9282670; Fax: (972)-3-9282498





(Name,
Telephone, E-mail and/or Facsimile number and Address of Company Contact
Person)




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




Title
      of class
              
              Name
      of each exchange on which registeredAmerican
      Depositary Shares, each
                representing
      one Ordinary Share (1)
              
              New
      York Stock Exchange, Inc.Ordinary
      Shares, par value NIS 1.0 per share(2)
              
              New
      York Stock Exchange, Inc.




(1)
            Evidenced
      by American Depositary Receipts.


(2)
            Not
      for trading, but only in connection with the listing of the American
      Depositary Shares.




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




None





(Title of
Class)




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




None





(Title of
Class)




Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual
report:




43,372,819 Ordinary Shares,
par value NIS 1.0 per share




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




Yes ̈Nox




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 1934.




Yes ̈Nox




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




xYes    ̈
No




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




Large
Accelerated filer  o                Accelerated
filer  x               Non-accelerated
filer  o




Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:




U.S. GAAP o




International Financing Reporting
Standards as issued by the International Accounting


Standards Board x





Other
o




If
"Other" has been checked in response to the previous question, indicate by check
mark which financial statement item the registrant has elected to
follow.


Item 17  o 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).




YesoNox





INTRODUCTION




Unless
otherwise indicated, as used in this Annual Report, (a) the term “Blue
Square” or the “Company” means Blue Square-Israel Ltd., (b) the terms “we,”
“us” and “our,” mean Blue Square and its consolidated subsidiaries, (c) “BSIP”
means Blue Square Chain Investments & Properties Ltd., our wholly-owned
subsidiary,  (d) "BSRE" means Blue Square Real Estate Ltd., a
corporation of which we held 78.45% of the outstanding shares as of June 15,
2009, and the balance of whose shares are publicly held and traded on the Tel
Aviv Stock Exchange and (e) "Bee Group" means Bee Group Retail Ltd. (formerly
known as Hamachsan Hamerkazi Kfar Hasha’ashuim Ltd.), a corporation of which we
held 85% of the outstanding ordinary shares as of June 15, 2009.




We
are the second largest food retailer in the State of Israel.  We also
operate in the "Non-Food" sector, selling “Non-Food” items both in our
supermarkets and in stand alone retail outlets. We also operate in the
yield-generating commercial real estate sector, in which we own, lease and
develop yield-generating commercial properties.




Through
our supermarkets, which are owned and operated through BSIP, we offer a wide
range of food and beverages products and “Non-Food” items, such as houseware,
toys, small electrical appliances, computers and computer accessories,
entertainment and leisure products and textile products (called “Non-Food” in
this Annual Report), and “Near-Food” products, such as health and beauty aids,
infants products, cosmetics and hygiene products (called “Near-Food” in this
Annual Report). As of December 31, 2008, we owned and operated 194
supermarkets under the brand names Mega, Mega in Town, Shefa Shuk, Mega Bool and
Eden Briut Teva Market (“Eden Nature”).




In
addition, as of December 31, 2008, the Bee Group consisted of 241 non-food
retail outlets, mostly through franchisees, with activities in the houseware and
home textile, toys, leisure, and baby and young children sectors.




As of
December 31, 2008, we were the legal owner (including through long-term leases
from the Israel Land Administration) of 98 properties owned in connection with
the retail operation of our stores (including warehouses and offices), totaling
approximately 201,700 square meters, 34 yield generating real estate properties
(including property leased to third parties), totaling approximately 63,200
square meters, and 21 properties of undeveloped land intended for future
development, totaling approximately 174,700 square meters. For further
information regarding our real estate, see “Item 4. Information on the Company -
B. Business Overview – Our Real Estate.”




Our
revenues and profits during the years described in this Annual Report were
principally derived from the operation of our supermarkets. In recent years, we
have increased our activity in the "Non-Food" retail, mainly through
acquisitions.  We expect that the acquisitions we have made in the
"Non-Food" retail area will have an increasing effect on our financial results
in the coming years.




Please
note that unless otherwise indicated, as used in this Annual Report, the term
“owned” or “ownership” with respect to our supermarkets means the ownership of
the operations of our supermarkets, and not legal title to the real estate
underlying our supermarkets.







We were
incorporated in June 1988. In 1996, we completed our initial public
offering and our American Depositary Shares, or ADSs, were listed for trading on
the New York Stock Exchange.  In November 2000, our ordinary
shares were listed for trading on the Tel Aviv Stock Exchange.




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 operating results.  Actual results could
differ materially from those anticipated in these forward-looking statements as
a result of various factors, including all the risks discussed in “Item
3.  Key Information - D. Risk Factors” and elsewhere in this Annual
Report.




We urge
you to consider that statements which use the terms “believe,” “do not believe,”
“expect,” “plan,” “intend,” “estimate,” “anticipate,” “project” and similar
expressions are intended to identify forward-looking
statements.  These statements reflect our current views with respect
to future events and are based on assumptions and are subject to risks and
uncertainties.  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.




All
references in this Annual Report to dollars or $ are to U.S. dollars and all
references in this Annual Report to NIS are to New Israeli Shekels. Unless
mentioned otherwise, all figures in U.S. dollars are based on the representative
exchange rate between the NIS and the dollar as published by the Bank of Israel
for December 31, 2008, which was NIS 3.802 per $1.00, except figures for the
first quarter of 2009, which are based on the representative exchange rate
between the NIS and the dollar as published by the Bank of Israel for March 31,
2009, which was NIS 4.188 per $1.00.




Presentation
of Financial and Share Information





We
prepare our consolidated financial statements in accordance with International
Financial Reporting Standards ("IFRS") as issued by the International Accounting
Standards Board ("IASB"). These are our first annual consolidated financial
statements that were prepared in accordance with IFRS as issued by the IASB and
IFRS 1-"First Time Adoption of International Financial Reporting
Standards".  Until and including our financial statements for the year
ended December 31, 2007, we prepared our consolidated financial statements in
accordance with Israeli GAAP. The influence of the transition to IFRS (from
financial statements prepared in accordance with generally accepted accounting
principles in Israel, referred to in this Annual Report as Israeli GAAP) on our
financial statements for the year ended December 31, 2007 and our results of
operations for that year, is detailed in note 36 to our consolidated annual
financial statements included in this annual report. Following the Company's
adoption of IFRS, as issued by the IASB, the Company is no longer required to
reconcile its financial statements prepared in accordance with IFRS to
U.S.GAAP.





TABLE
OF CONTENTS




PagePART
      I
                                                                          
                                                                          2ITEM
      1.
                                                                          IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
                                                                          2ITEM
      2.
                                                                          OFFER
      STATISTICS AND EXPECTED TIMETABLE
                                                                          2ITEM
      3.
                                                                          KEY
      INFORMATION
                                                                          2ITEM
      4.
                                                                          INFORMATION
      ON THE COMPANY
                                                                          23ITEM
      4A.
                                                                          UNRESOLVED
      STAFF COMMENTS
                                                                          59ITEM
      5.
                                                                          OPERATING
      AND FINANCIAL REVIEW AND PROSPECTS
                                                                          59ITEM
      6.
                                                                          DIRECTORS,
      SENIOR MANAGEMENT AND EMPLOYEES
                                                                          87ITEM
      7.
                                                                          MAJOR
      SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
                                                                          112ITEM
      8.
                                                                          FINANCIAL
      INFORMATION
                                                                          129ITEM
      9.
                                                                          THE
      OFFER AND LISTING
                                                                          133ITEM
      10.
                                                                          ADDITIONAL
      INFORMATION
                                                                          136ITEM
      11.
                                                                          QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                                                                          153ITEM
      12.
                                                                          DESCRIPTION
      OF SECURITIES OTHER THAN EQUITY SECURITIES
                                                                          156PART
      II
                                                                          
                                                                          156ITEM
      13.
                                                                          DEFAULTS,
      DIVIDEND ARREARAGES AND DELINQUENCIES
                                                                          156ITEM
      14.
                                                                          MATERIAL
      MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
      PROCEEDS
                                                                          156ITEM
      15.
                                                                          CONTROLS
      AND PROCEDURES
                                                                          156ITEM
      16.
                                                                          [RESERVED]
                                                                          158ITEM
      16A.
                                                                          AUDIT
      COMMITTEE FINANCIAL EXPERT
                                                                          158ITEM
      16B.
                                                                          CODE
      OF ETHICS
                                                                          158ITEM
      16C.
                                                                          PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
                                                                          158ITEM
      16D.
                                                                          EXEMPTIONS
      FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
                                                                          159ITEM
      16E.
                                                                          PURCHASES
      OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
    PURCHASERS.
                                                                          159ITEM
      16F.
                                                                          CHANGE
      IN REGISTRANT'S CERTIFYING ACCOUNTANT.
                                                                          159ITEM
      16G.
                                                                          CORPORATE
      GOVERNANCE
                                                                          159Part
      III
                                                                          
                                                                          161ITEM
      17.
                                                                          FINANCIAL
      STATEMENTS
                                                                          161ITEM
      18.
                                                                          FINANCIAL
      STATEMENTS
                                                                          161ITEM
      19.
                                                                          EXHIBITS
                                                                          161




1




PART
I




ITEM
      1.
              IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND
ADVISERS




Not
applicable.




ITEM
      2.
              OFFER
      STATISTICS AND EXPECTED
TIMETABLE




Not
applicable.




ITEM
      3.
              KEY
      INFORMATION




A.              Selected
Financial Data.




We have
derived the following selected consolidated financial data as of
December 31, 2007 and 2008 and for each of the years ended
December 31, 2007 and 2008 from our consolidated financial statements and
notes included elsewhere in this Annual Report.  We have derived the
selected consolidated financial data as of December 31, 2004, 2005, and
2006 and for each of the years ended December 31, 2004, 2005 and 2006 from
our audited consolidated financial statements not included in this Annual
Report.  We prepare our consolidated financial statements in
conformity with IFRS.  Until and including our financial statements
for the year ended December 31, 2007, we prepared our consolidated financial
statements in accordance with Israeli GAAP.To facilitate
comparison with the financial results of the year 2008, results from the year
ended December 31, 2007 have been adjusted in accordance with IFRS and differ
from the results reported previously.  See Item 5. “Operating and
Financial Review and Prospects.”  You should read the selected
consolidated financial data together with the section of this Annual Report
titled “Item 5.  Operating and Financial Review and Prospects”, our
consolidated financial statements included elsewhere in this Annual Report, the
related notes, and the independent registered public accounting firm's report
which contains emphasis paragraphs regarding the adoption of IFRS for the first
time in 2008.





The
selected information also includes certain items for the years 2004 to 2006 in
accordance with U.S. GAAP.  Israeli GAAP differs in certain
significant respects from U.S. GAAP.  For a summary of certain
significant differences, see note 21 to our consolidated financial statements
for the year ended December 31, 2007.




2




For
      the year ended December 31,2007
                
                
                2008
                
                
                2008NIS
      (In thousands, except
                    per
      ordinary share or ADS
                    data)
                
                
                
                $(1)Statement
      of Income Data:
                  In
      accordance with IFRSSales
                
                
                6,981,984
                
                
                
                7,429,121
                
                
                
                1,954,003Cost
      of sales
                
                
                5,129,578
                
                
                
                5,369,149
                
                
                
                1,412,191Gross
      profit
                
                
                1,852,406
                
                
                
                2,059,972
                
                
                
                541,812Selling,
      general and administrative expenses
                
                
                1,563,208
                
                
                
                1,794,720
                
                
                
                472,046Operating
      profit before other gain and losses and net gain from adjustment of
      investment property to fair value
                
                
                289,198
                
                
                
                265,252
                
                
                
                69,766Other
      gains
                
                
                15,835
                
                
                
                12,233
                
                
                
                3,218Other
      losses
                
                
                (12,755
                )
                
                
                (14,716
                )
                
                
                (3,870
                )Net
      gain from adjustment of investment property to fair value
                
                
                10,456
                
                
                
                19,067
                
                
                
                5,015Operating
      profit
                
                
                302,734
                
                
                
                281,836
                
                
                
                74,129Finance
      income
                
                
                60,978
                
                
                
                60,700
                
                
                
                15,965Finance
      expenses
                
                
                (118,297
                )
                
                
                (166,295
                )
                
                
                (43,739
                )Finance
      expenses, net
                
                
                57,319
                
                
                
                105,595
                
                
                
                27,774Share
      in profit (loss) of associates
                
                
                186
                
                
                
                (33
                )
                
                
                (9
                )Income
      before taxes on income
                
                
                245,601
                
                
                
                176,208
                
                
                
                46,346Taxes
      on income
                
                
                69,779
                
                
                
                43,806
                
                
                
                11,522Profit
      for the year
                
                
                175,822
                
                
                
                132,402
                
                
                
                34,824Attributable
      to:Equity
      holders of the company:
                
                
                143,628
                
                
                
                104,586
                
                
                
                27,508Minority
      interests
                
                
                32,194
                
                
                
                27,816
                
                
                
                7,316Earnings
      per Ordinary share or ADS attributable to equity holders of the
      Company:Basic
                
                
                3.39
                
                
                
                2.41
                
                
                
                0.63Diluted
                
                
                3.39
                
                
                
                1.62
                
                
                
                0.43Cash
      dividends declared per ordinary share or ADS
                
                
                6.52
                
                
                
                3.46
                
                
                
                0.91Number
      of Ordinary Shares Outstanding:
                
                
                43,372,819
                
                
                
                43,372,819
                
                
                
                N/ASelected
      Operating Data:Number
      of supermarket stores (at year end)
                
                
                185
                
                
                
                194
                
                
                
                N/AIncrease
      in same store sales(2)
                
                
                1.20
                %
                
                
                1.10
                %
                
                
                N/ATotal
      square meters (at year end)
                
                
                342,705
                
                
                
                354,531
                
                
                
                N/ASupermarket
      sales per square meter (in NIS)(3)
                
                
                19,905
                
                
                
                19,898
                
                
                
                5,234




3




For
      the year ended December 31,2007
                  
                  
                  2008
                  
                  
                  2008NIS
      (In thousands, except
                      per
      ordinary share or ADS
                      data)
                  
                  
                  
                  $(1)Supermarket
      sales per employee (in thousands) (4)
                  
                  
                  937
                  
                  
                  
                  954
                  
                  
                  
                  251




For
      the year ended December 31,2004
                
                
                2005
                
                
                2006NIS
      (In thousands, except per ordinary
                    share
      or ADS data)Statement
      of Income Data:
                  In
      accordance with Israeli  GAAPSales
                
                
                5,365,784
                
                
                
                5,797,018
                
                
                
                6,515,035Cost
      of sales
                
                
                3,962,303
                
                
                
                4,298,211
                
                
                
                4,812,952Gross
      profit
                
                
                1,403,481
                
                
                
                1,498,807
                
                
                
                1,702,083Selling,
      general and administrative expenses
                
                
                1,203,391
                
                
                
                1,269,760
                
                
                
                1,396,877Operating
      income
                
                
                200,090
                
                
                
                229,047
                
                
                
                305,206Financial
      expenses, net
                
                
                (58,090
                )
                
                
                (59,529
                )
                
                
                (42,368
                )Amortization
      of goodwill
                
                
                (5,870
                )
                
                
                (6,508
                )
                
                
                -Other
      income (expenses), net
                
                
                (19,593
                )
                
                
                690
                
                
                
                78,022Taxes
      on income
                
                
                41,230
                
                
                
                58,490
                
                
                
                96,660Equity
      in net earnings (loss) of affiliates
                
                
                (1,204
                )
                
                
                498
                
                
                
                1,284Minority
      interest
                
                
                13,555
                
                
                
                15,717
                
                
                
                31,573Net
      income
                
                
                60,548
                
                
                
                89,991
                
                
                
                213,911Earnings  per
      ordinary share or ADS (basic)
                
                
                1.57
                
                
                
                2.32
                
                
                
                5.46Earnings
      per ordinary share or ADS (fully diluted)
                
                
                1.54
                
                
                
                2.26
                
                
                
                4.92Cash
      dividends declared per ordinary share or ADS
                
                
                6.38
                
                
                
                2.35
                
                
                
                2.81In
      accordance with U.S. GAAP:Net
      income
                
                
                45,235
                
                
                
                88,340
                
                
                
                166,724Earnings
      per ordinary share or ADS (basic)
                
                
                1.17
                
                
                
                2.27
                
                
                
                4.25Earnings
      per ordinary share or ADS (fully diluted)
                
                
                1.17
                
                
                
                2.27
                
                
                
                4.23Number
      of  Ordinary Shares Outstanding:
                
                
                38,782,336
                
                
                
                38,950,091
                
                
                
                39,692,983Selected
      Operating Data:Number
      of supermarket stores (at year end)
                
                
                164
                
                
                
                168
                
                
                
                175Increase
      (decrease) in same store sales (2)
                
                
                (1.3
                )%
                
                
                1.7
                %
                
                
                5.3
                %Total
      square meters (at year end)
                
                
                300,000
                
                
                
                312,000
                
                
                
                323,304




4




For
      the year ended December 31,2004
                    
                    
                    2005
                    
                    
                    2006NIS
      (In thousands, except per ordinary
                        share
      or ADS data)Supermarket
      sales per square meter (in NIS)(3)
                    
                    
                    18,074
                    
                    
                    
                    18,621
                    
                    
                    
                    19,739Supermarket
      sales per employee (in thousands) (4)
                    
                    
                    867
                    
                    
                    
                    899
                    
                    
                    
                    938





(1)
            The
      translation of the NIS amounts into dollars has been made for the
      convenience of the reader at the representative exchange rate prevailing
      at December 31, 2008 (NIS 3.802=$1.00), as
      published by the Bank of Israel. During 2008, the US dollar depreciated in
      value vis-à-vis the NIS by approximately
(1.2)%.




(2)
            The
      percentage in same store sales is the percentage change in sales of those
      stores that operated continuously during the entire reporting period of
      both the current year and that preceding it. Stores are not deemed to have
      operated continuously (and therefore not included as “same stores”) if
      such stores were permanently closed during the reporting period or the
      preceding period, were resized significantly during the period or were
      significantly renovated or expended during the period. Store resizing is
      considered significant if it exceeds 5% or more of the store’s original
      size.




(3)
            Based
      on an average total square meters at month end during the relevant
      year.




(4)
            In
      2005, the Company began outsourcing its cleaning activities to external
      services providers, which reduced its total number of employees as
      compared to 2004. To facilitate a meaningful comparison between the
      Company’s Sales Per Employee for 2005, 2006, 2007 and 2008 with the Sales
      Per Employee for the previous period, the number of employees used to
      calculate Sales Per Employee for 2004 has been adjusted to exclude
      cleaning personnel.




At
      December 31,2007
                    
                    
                    2008
                    
                    
                    2008NIS
      (in thousands)
                    
                    
                    
                    $(1)Balance
      Sheet Data:In
      accordance with IFRSWorking
      capital (deficit)
                    
                    
                    47,436
                    
                    
                    
                    (74,926
                    )
                    
                    
                    (19,706
                    )Total
      assets
                    
                    
                    4,219,071
                    
                    
                    
                    4,445,027
                    
                    
                    
                    1,169,128Short-term
      credit from banks and others and current maturities of
      debentures
                    
                    
                    240,869
                    
                    
                    
                    236,900
                    
                    
                    
                    62,309Long-term
      debt, net of current maturities
                    
                    
                    1,202,858
                    
                    
                    
                    1,497,880
                    
                    
                    
                    393,972Total
      equity
                    
                    
                    1,247,680
                    
                    
                    
                    1,096,002
                    
                    
                    
                    288,269




5




At
      December 31,2004
                  
                  
                  2005
                  
                  
                  2006NIS
      (in thousands)Balance
      Sheet Data:In
      accordance with Israeli GAAP:Working
      capital (deficit)
                  
                  
                  (380,666
                  )
                  
                  
                  (450,044
                  )
                  
                  
                  335,376Total
      assets
                  
                  
                  3,079,011
                  
                  
                  
                  3,683,035
                  
                  
                  
                  4,071,733Short-term
      credit from banks and others and current maturities of
      debentures
                  
                  
                  136,541
                  
                  
                  
                  359,316
                  
                  
                  
                  264,858Long-term
      debt, net of current maturities
                  
                  
                  776,568
                  
                  
                  
                  1,102,810
                  
                  
                  
                  1,161,926Shareholders’
      equity
                  
                  
                  819,310
                  
                  
                  
                  865,308
                  
                  
                  
                  992,922In
      accordance with U.S. GAAP:Total
      assets
                  
                  
                  3,147,284
                  
                  
                  
                  3,757,640
                  
                  
                  
                  4,247,394Shareholders’
      equity
                  
                  
                  873,120
                  
                  
                  
                  928,504
                  
                  
                  
                  1,003,384




(1)
            The
      translation of the NIS amounts into dollars has been made for the
      convenience of the reader at the representative exchange rate prevailing
      at December 31, 2008 (NIS 3.802= $1.00), as published by the
      Bank of Israel.




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, our business, operating results and financial
condition could be materially adversely affected and the share and ADS price of
Blue Square may decline.  We cannot assure you that we will
successfully address any of these risks.




6




We
are engaged in a highly competitive business.  If we are unable to
compete effectively against low-priced supermarkets and other competitors, our
business will be materially adversely affected.




Supermarkets


The food
retailing industry in Israel is highly competitive and is characterized by high
turnover and narrow operating margins. We compete with the other major
supermarket chain, Shufersal (formerly known as Super Sol), low-priced smaller
supermarket chains, independent grocers, open-air markets, and other retailers
selling supermarket goods. Competitive pressures increase as the supermarket
sector in Israel approaches higher saturation levels and continue to increase as
our competitors expand their operations and new companies enter the market with
hard discount formats.




We
believe that an important factor in the purchase decisions of a large portion of
the Israeli public is the price of the products it purchases. As a result, in
recent years, we and our competitors have established or expanded low-price and
hard discount store formats. During the third quarter of 2007, we launched our
“Mega In Town” format designed to bring discount shopping to neighborhoods and
city centers. During the fourth quarter of 2008, we launched our new hard
discount store format, "Mega Bool".




In
addition, smaller supermarket chains during 2008 continued to increase their
market share and expand their presence in selected areas in Israel (including by
mergers and acquisitions), often geographically beyond their original locations,
increasing competition in an already difficult market.  Based on A.C.
Nielsen, we estimate that the smaller supermarket chains' market share was
approximately 28.0% of the bar-coded market in Israel in 2008. The low barriers
of entry, including the relatively low cost of establishing a new smaller
supermarket chain, have contributed to the increase in number and expansion of
smaller supermarket chains in recent years. These smaller
supermarket  chains have been able to capture a significant part of
the sales from the major chains in their areas by using lower cost non-unionized
labor and having lower operating costs and, in some cases by operating on
Saturdays and offering non-kosher food.  Large supermarket chains in
Israel, including us, are kosher and therefore do not offer non-kosher food or
generally operate on Saturdays.




In 2005,
a number of smaller supermarket chains which operate on local geographic level
combined to form a separate entity, Fourth Chain Company Ltd., in order to
develop a private label and to jointly negotiate with suppliers. In 2006, the
Fourth Chain Company started to market a private label brand.  This
combination, and possible similar combinations of other smaller supermarket
chains, may generate efficiencies of a major national-spread chain and enable
them to compete more efficiently with us.




Since the
merger of Shufersal with ClubMarket, another major chain, in 2005, we have faced
a larger competitor, many of whose stores are characterized by the every day
sale of products at low prices.  Based on A.C. Nielsen, we estimate
that Shufersal's market share was approximately 36.9% of the bar-coded market in
Israel in 2008, as opposed to our own approximately 21.4% share of the bar-coded
market in 2008.  This difference in market share may give Shufersal a
greater competitive advantage in its dealings with customers, suppliers and
other third parties.




If we are
unable to maintain our current level of sales or if we lose market share to our
competitors, our negotiating position with suppliers, which is based, in part,
on our market share in the Israeli retail market, and our revenues may be
adversely affected, with a corresponding impact on profitability. We cannot
assure you that we will be able to maintain our sales and market
share.


7




Non-Food
Retail




The
merchandise we sell in our non-food retail business through Bee Group is varied,
and we therefore compete in several different markets. Accordingly, our
"Naaman", "Sheshet" and "Vardinon" stores compete in the houseware, home textile
and accompanying accessories markets. Our "Dr. Baby" stores compete in the baby
and young children accessories market, and our "All for a Dollar" and "Kfar
Hasha’ashuim" stores compete in the toys and leisure accessories market and the
back-to-school products market.





In recent
years competition in the non-food retail industry has increased, primarily due
to the entry of retail chains and stores outside the food industry, such as Toys
“R” Us, Office Depot, do-it-yourself chains such as Home Center and ACE (a
franchisee of Ace Hardware), household stores, home textile stores, houseware
stores, electricity appliances stores and also due to the expansion of the
houseware and home textile departments in supermarkets. This competition affects
the sales prices of our products and the scope of our
sales.  Nevertheless, our Sheshet chain is positioned as a chain that
provides products at competitive prices. Increased competition may adversely
affect our scope of sales and our profitability.





In
addition, the barriers of entry are low in some of the markets in which the Bee
Group competes due to the price and availability of products from overseas
suppliers, although the establishment of a network of stores throughout the
country together with the required import and marketing of products requires a
high level of investment.  The entrance of new competitors may reduce
our market share and may reduce the sale prices of our products and lead to a
reduction in our profitability.





Economic
conditions in Israel affect our financial performance.




Supermarkets
and Non-Food Retail




All of
our supermarket sales are made in Israel, and we acquire a substantial majority
of the goods that we sell from Israeli suppliers. Consequently, our financial
performance is dependent to a significant extent on the economy of Israel.
During 2006, 2007 and 2008, Israel's Gross Domestic Product rose by 5.1%, 5.3%
and 4.1%, respectively.  However, in recent quarters, the global
economic crisis, instability and uncertainty have affected the economic
conditions in Israel. Initial reports indicate that the Israeli economy declined
by 3.9% (annualized) at the first quarter of 2009. We believe that the economic
slowdown is affecting the buying patterns of our customers, as more customers
are shifting their purchases to low-price and hard discount stores, which have a
lower profit margin.  As a result, we have expanded our low-price and
hard discount store formats.  We expect the economic slowdown in
Israel to adversely affect our financial performance, among other things, by
reducing our sales and our profitability.




8




The
global economic crisis, instability and uncertainty have also affected our
non-food retail business by a slowdown in the growth of private consumption,
which could affect the growth of our houseware, home textile and baby and young
children accessories businesses.




In
addition, the global economic crisis has also reduced the availability of
credit, increased the costs of financing and the terms under which banks agree
to provide financing.  These developments may reduce our sales,
increase our costs of borrowing and reduce our profitability.




In
addition, on May 13, 2009, Israel's cabinet approved the proposed state budgets
for the years 2009 and 2010, which include, among other things, a temporary
increase of 1% in the value added tax ("VAT") from 15.5% to 16.5% for an
18-month period, and an imposition of VAT, for the first time, on fruits and
vegetables. The temporary increase in VAT to 16.5% is effective, although the
proposal to impose VAT on fruits and vegetables is subject to change. The
Knesset (Israeli legislative body) is expected to vote on the budget by
mid-July.  The increase in VAT and the new imposition of VAT on fruits
and vegetables will increase the cost of the products that we sell in our
supermarkets and may affect our sales.




Real
Estate





We value
our yield-generating real estate property according to IAS 40 and changes to the
fair value of our real estate are reflected in our financial
statements.  The fair value of our properties could be impacted by a
number of factors, including the global economic and financial market crisis, as
well as the retail sector in Israel because most of our assets are intended for
retail businesses. Reductions in the fair value of our real estate may
materially adversely affect our financial results.





We
have a history of quarterly fluctuations in our operating results and expect
these fluctuations to continue due to seasonality.  This may cause the
share and ADS price of Blue Square to be volatile.




Our
business is subject to fluctuations in quarterly sales and profits. These
fluctuations are primarily attributable to increased sales and higher operating
income in the holiday seasons occurring in different quarters from year to
year.  Thus, for example, in our supermarkets, and in our "Naaman",
"Vardinon" and "Sheshet" chains, increased sales attributable to Passover, which
occurs in either March or April, may be realized in either the first or the
second quarter, and sales attributable to the Jewish New Year, which occurs in
either September or October, may be realized in either the third or the
fourth quarter. In our "Kfar Hasha'ashuim" chain, increased sales are generally
attributable to Purim, which occurs in March, and to the "Back-to-School" season
in August.  However, the timing of the holidays does not affect our
semiannual results.




Many of
our expenses are unrelated to the level of sales.  Therefore, a
relatively modest increase or decrease in sales, whether or not related to the
timing of holidays, tends to have a disproportionately large impact on our
profitability.


9




Because
of the fluctuations that we have experienced in our quarterly operating results,
we do not believe that period-to-period comparisons of our operating results are
necessarily meaningful or should necessarily be relied upon as indicators of
future performance. Accordingly, our operating results may be below public
expectations in future periods. Our failure to meet these expectations may cause
the share and ADS price of Blue Square to decline.




To
maintain the credit rating on our 5.9% unsecured debentures issued in August
2003, we are limited in our ability to pay cash dividends on our ordinary
shares.




In
connection with our issuance of NIS 400 million in aggregate principal amount of
unsecured 5.9% convertible and nonconvertible debentures in August 2003, Blue
Square’s board of directors resolved that Blue Square would not distribute
dividends in any quarter if the ratio of our net financial obligations (as
defined by S&P-Maalot, an Israeli rating agency owned by S&P) to EBITDA
for any quarter exceeds 3.5 until June 30, 2006 or exceeds 3.0
thereafter.  Blue Square’s board of directors also resolved that Blue
Square would not distribute dividends in any quarter if the ratio of the
unencumbered fixed assets (following depreciation) and investment property as
set forth on our financial statements to financial obligations (as defined by
S&P-Maalot) for any quarter is below 120%.  S&P-Maalot has
informed us that a change in this board of directors resolution may lead to a
downgrading of the rating on our 5.9% unsecured debentures.  Following
the dividends distributions of 2003 through 2008, the retained earnings of
Blue Square decreased significantly. According to our unaudited financial
reports, as of March 31, 2009, the ratio of the Company's financial obligations
to EBITDA was 3.6, and the ratio of its unencumbered fixed assets to the
financial obligations was 160%.  To maintain the credit rating of our
5.9% unsecured debentures, we are currently unable to pay cash dividends on our
ordinary shares.




We
are dependent to a significant extent on a limited number of key
suppliers.  If these suppliers raise prices or encounter difficulties
in providing their products, our operating results will be adversely
affected.




We
purchase most of our dairy, fresh produce and poultry products from the Tnuva
corporation, which holds a leading position in the domestic dairy and poultry
markets. In 2008, Tnuva’s products accounted for approximately 14% of all the
products sold at our supermarkets. In addition, the Strauss group, an Israeli
food manufacturer, accounted in 2008 for approximately 9.4% of all products sold
at our supermarkets, and the Osem group accounted for approximately 6.9% of all
products sold at our supermarkets in 2008.  Because of our status as a
leading food retailer in Israel as a result of which we are able to offer a wide
exposure and promotion, on a national level, to these suppliers’ products, and
the fact that we maintain an excellent and long-standing relationship with
Tnuva, Strauss group and Osem, we do not believe that there is a material risk
of future stoppage of supply of products of these key suppliers. However, we do
not have a written contract with Tnuva, Strauss group or Osem obligating them to
supply products to us. The ten largest suppliers accounted for approximately
51.8% of our product purchases in 2008. Due to the relatively large market share
of these suppliers, we depend on them and on a number of other suppliers that
supply brands characterized by high customer loyalty, such as the Central
Company for the Manufacture of Soft Drinks Ltd., which is the exclusive
franchisee of Coca Cola and also distributes other popular soft
drinks.  For example, during the third and fourth quarters of 2007 and
during 2008, some of our suppliers raised the prices of various products that
they supply us, principally due to an increase in raw materials prices, which
caused an increase in our costs. Increases in prices by
our suppliers are generally not offset, fully or as quickly, by increases in our
selling prices and revenues because of competitive pressures.  We
cannot assure that, in the future, Tnuva, Strauss group, Osem or any of these
other suppliers will not significantly raise the prices of the products they
supply us in the future, or encounter difficulties in providing these products
to us, in either of which cases our operating results might be adversely
affected.


10




Alon
Retail Ltd. (formerly Bronfman-Alon) is able to control the outcome of matters
requiring shareholder approval.




As of
June 15, 2009, Alon Retail Ltd., formerly Bronfman-Alon Ltd. ("Alon Retail"),
owned approximately 70.65% of Blue Square’s ordinary shares.  So long
as Alon Retail, or any successor to its shareholdings in Blue Square, continues
to own beneficially more than 50% of our outstanding ordinary shares and voting
power, it will be able to control the outcome of matters requiring shareholder
approval that do not require a special majority, including the election of all
Blue Square directors, other than Blue Square two external directors whose
election, under the Israeli Companies Law, requires that at least one-third of
the non-controlling shareholders who participate in the vote, vote for their
nomination, or that the total number of shares of non-controlling shareholders
voted against their nomination does not exceed one percent of the aggregate
voting rights in the company.




We own a majority interest in most of
our subsidiaries. As a majority shareholder, we owe fiduciary duties to the
minority shareholders of our subsidiaries and have to share dividends and
distributions with these minority shareholders.




In
addition to our wholly owned subsidiary, BSIP, our two main subsidiaries are Bee
Group, in which we owned an 85% interest (with an option to further increase our
holdings to 100%) as of June 15, 2009, and BSRE, in which we owned a 78.45%
interest as of June 15, 2009.




Through
our subsidiary, Bee Group, we hold approximately 66.85% of the outstanding
shares of Naaman Porcelain Ltd., which holds an approximately 88.74% of the
voting power and 71.15% of the share capital interest in Vardinon Textile Ltd.,
both of which are publicly held and traded on the Tel Aviv Stock
Exchange.  In addition, we own seven supermarkets through our 51%
subsidiary, Eden Briut Teva Market Ltd. ("Eden Nature").  The ordinary
shares of Eden Nature that are not owned by us are held by private third parties
(including the CEO of Eden Nature).




BSIP
leases from BSRE the real estate underlying a substantial portion of the
supermarkets that it owns.  The ordinary shares of BSRE that are not
owned by Blue Square are publicly held and traded on the Tel Aviv Stock
Exchange.


11




In order
to satisfy whatever fiduciary obligations we may have under applicable law to
the minority shareholders of our partially owned subsidiaries, we endeavor to
deal with each of these subsidiaries at “arm’s-length.”  Some
transactions between Blue Square and a subsidiary, including any cancellation of
such transactions, require the approval of the audit committee, the directors,
and, under certain circumstances, approval of the shareholders of the subsidiary
by special vote and are subject to the receipt of applicable permits and
approvals. In addition, any dividend or distribution from a subsidiary requires
the approval of the directors of that subsidiary, and may be subject to
restrictions imposed by loan and other agreements to which they are
parties.




In
recent years, we have expanded our non-food retail business by acquiring
businesses with stand alone retail outlets.  We may not be able to
successfully consolidate these business operations with our supermarket business
or to capitalize on potential synergies of the internal reorganization of our
non-food retail businesses.





As part
of our strategy to expand our presence in “Non-Food” stand alone retail outlets,
we acquired 50% of Bee Group in 2005 and by 2008 we had increased our holdings
in Bee Group to 85%. Concurrently, Bee Group acquired the controlling interest
in Vardinon Textile Ltd. (home textile retailer and wholesaler) and the
controlling interest in Naaman Porcelain Ltd. (houseware retailer and
wholesaler) (the "Bee Group Acquisition"), and Bee Group effected an internal
reorganization of its own subsidiaries in order to improve Bee Group's operating
efficiency.  Realization of the anticipated benefits of our Bee Group
acquisitions, including anticipated operating synergies among the various
subsidiaries of the Bee Group, and between the Bee Group and the Company as a
whole will depend, in large part, on our ability to successfully eliminate
redundant corporate functions and consolidate company and shared service
responsibilities. We will be required to devote significant management attention
and resources to the consolidation of business practices and support functions
while maintaining the independence of the Bee Group's stand alone brand
names.





The
process of consolidating corporate level operations could cause an interruption
of, or loss of momentum in, our business and financial performance. The
diversion of management’s attention and any delays or difficulties encountered
in connection with our Bee Group acquisitions and the realization of corporate
synergies and operational improvements could have an adverse effect on our
business, financial results, financial condition or share price. The
consolidation and integration process may also result in additional and
unforeseen expenses. There can be no assurance that the contemplated synergies
and other benefits anticipated from the Bee Group acquisition will be
realized.




In
addition, our expansion into the non-food retail business has required us to
enter new markets in which we have no or limited experience and where
competitors in such markets may have stronger market positions. If we are not
able to successfully compete against our more experienced competitors in the
stand alone retail outlet businesses, our business may be adversely
affected.


12




Failure
to obtain or maintain permits required for our operations may adversely affect
our operating results.




Our
operation of supermarkets in Israel requires permits from municipal authorities,
which are conditioned on the prior approval of various agencies, including the
health and environment ministries, and the police and fire
departments.  Some of these permits are currently in the name of the
Co-Op Blue Square Services Society, or the Co-Op, our former controlling
shareholder, and entities other than us, and have not yet been transferred or
re-issued to us.  Also, some of our stores require permits that have
not yet been obtained, or have expired or require renewal.




Some of
our Bee Group stores do not have permits according to the requirements of
Israeli Business Permits Law, 1968.  A lack of such permits by any
store would be considered a breach of the tenancy agreement for such store,
which would allow the landlord to annul the lease agreement. As of the date of
this Annual Report, none of the landlords has made use of this
right.





In
addition, Kfar Hashashuim received a court issued an order to vacate its
logistics center due to a lack of a permit to conduct its business in the
logistics center and a lack of building permits.  However, BSRE is in
the process of building a new logistics center for the Bee Group, and therefore
Kfar Hasha'ashuim has requested a delay in the execution of the closure order.
The court will hold its next hearing on the matter in October 2009, at which
time Kfar Hasha'ashuim must present to the court the status of the building of
the center. The execution of the order to vacate has been delayed until after
the hearing.





As a
result of the hostilities between Israel and the Palestinians, the relevant
authorities, including the police, have required us to adopt various security
measures.  These safety requirements prescribe extensive investment in
safety equipment, the retaining of security personnel and may lengthen the time
dedicated for obtaining permits from the municipal authorities.  If we
are unable to obtain or maintain one or more required permits, we may be
required to close one or more stores or to take other remedial action to obtain
or maintain these permits. For further information, see “Item 8. Financial
Information - A. Consolidated Statements and Other Financial Information - Legal
Proceedings - We are subject to legal proceedings in connection with business
licenses”.




Increase
in employee minimum wage in Israel may adversely affect our operating
results.




A
substantial portion of our employees’ wages is adjusted upon a change in the
minimum wage in Israel. Under Israeli law, the minimum wage, which is increased
from time to time as a result of various economic parameters and updating of
employee-union agreements, equals approximately 47.5% of the average wage for an
employee in Israel. Pursuant to existing legislation, the minimum monthly wage
was increased on July 1, 2008, to NIS 3,850 or approximately $973 (as of May 31,
2009).   An increase in minimum wage will increase our labor
costs and thus adversely affect our operating results


13




Future
issuances of our ordinary shares could reduce our share price.




Out of
the NIS 400 million in aggregate principal amount of unsecured 5.9% debentures
that we issued in August 2003, NIS 200 million in aggregate principal amount
were convertible debentures (principal repayable in three equal installments in
the years 2007, 2009 and 2011) which as of June 15, 2009 were convertible into
Blue Square ordinary shares at per share price of NIS 20.095. This conversion
ratio is subject to adjustment in the event of distribution of bonus shares,
cash dividends and the issuances of rights. On June 15, 2009, the closing price
per share of our ordinary shares on the Tel Aviv Stock Exchange was NIS 35.21.
As of June 15, 2009, the remaining principal balance of our convertible
debentures was approximately NIS 33.5 million. In January, 2008, we adopted a
share option plan for officers and employees of Blue Square and its subsidiaries
and affiliates.  The total number of shares reserved for issuance
under the plan is five million shares, subject to adjustments.  See
"Item 6.  Directors, Senior Management and Employees - E. Share
Ownership".




The
issuance of ordinary shares to holders of our convertible debentures or to
holders of options under our share option plan, or the perception that those
issuances may occur in the future, could materially and adversely affect the
market price for our ordinary shares.




The Israeli Antitrust
Authority may take
actions that limit our ability to execute our business strategy or otherwise
affect our profitability.




Our
strategy includes expanding our market presence in existing retail food markets
and entering into new retail food and “Non-Food” markets.  The Israeli
Antitrust Authority may limit our ability to execute our strategy, inter alia, by limiting our
ability to acquire existing stores or enter into mergers to acquire existing
stores.




On
January 5, 2005, the Commissioner of the Israeli Antitrust Authority issued his
final position regarding“commercial restrictive
practices between the dominant food suppliers and the major supermarket retail
chains”. According to the Commissioner’s final position, some of these practices
were found to be restrictive trade agreements under the antitrust laws. The
Commissioner prohibited these practices unless approved by the Restrictive Trade
Practices Court or exempted by the Commissioner himself.


14


Among the
practices that were found to be restrictive according to the Commissioner were
the following: arrangements with suppliers that determine the suppliers of the
retail chains, their identity and their number; arrangements for the management
of product categories in conjunction with suppliers; arrangements regarding the
retail selling price; arrangements for determining market share of a particular
supplier’s products and arrangements for determining prices made by suppliers to
competing chains; arrangements with regard of the use of suppliers’ manpower to
stock merchandise on the shelves of the chains’ stores.  Limits were
imposed on financial benefits to the chains with regard to display areas and on
special offers to chains for meeting certain sale targets.




We
have been applying most of these directives among others, by an internal
compliance program that we have adopted.




Presently
we do not know how, if at all, our business would be affected should the
Commissioner take any action against us with respect to those issues under
dispute which we believe are legal based on our consultations with our legal
counsel.




In August
2006, the Restrictive Trade Practices Court approved a consent decree reached
between the Commissioner and certain specific food suppliers.  The
consent decree stipulates various prohibitions, conditions and restrictions that
would apply to certain practices of these suppliers. The consent decree
addresses the following practices: arrangement by which suppliers influence the
number or identity of competing suppliers; acquisition of shelf and off-shelf
display space; category management; the use of suppliers’ representatives to
physically arrange the shelves in the chains’ stores; discounts and rebates in
exchange for meeting sales targets; arrangements that determine a supplier’s
market share; exclusivity in sales and price dictation by
suppliers.  The Company is not a party to the consent decree; however,
it could nevertheless have an effect on the practices of the Company’s suppliers
and indirectly on the Company.




For more
information on this and other action taken by the Israeli Antitrust Authority,
please see “Item 4. Information on the Company - B. Business Overview -
Government Regulation”.




Increases
in oil, raw material and product prices in recent years may affect our operating
results




The sharp
increase in oil prices in recent years has led to the increase in our
electricity prices and raw materials used in the plastic packing industry. In
2008, a number of our suppliers increased their product prices to us due to
increases in raw material prices. Further increase in oil, raw material and
product prices would impose on us significant expenses and costs, which could
have an adverse effect on our operation results.




Impact
of inflation may adversely affect our financial expenses and operating
income.




Our
non-financial assets and shareholders equity are not adjusted to the inflation
in Israel, while the repayment of interest and principal under part of our loans
and all debentures are adjustable, linked to changes to the Israeli consumer
price index, as provided in our loan and debenture agreements. As a result, an
increase in inflation in Israel would have the effect of increasing our
financial expenses without any corresponding offsetting increase in our assets
and revenues on our financial statements, leading to lower reported earnings and
shareholders equity. The extent of this effect on our financial statement would
be dependent on the rate of inflation in Israel. The Company has an excess of
CPI-linked liabilities over CPI-linked assets (mainly in respect of outstanding
debentures). Toward the end of 2008, we engaged in transactions to partially
hedge this inflation risk. We engage in these transactions from time to time to
reduce our risk to inflation, although we do not eliminate the risk of
inflation.




15


In
addition, some of our operating expenses are either linked to the Israeli
consumer price index (such as lease payments payable by us under various real
estate property leases in connection with our operations) or are indirectly
affected by an increase in Israeli consumer price index.  As a result,
an increase in the inflation rate in Israel would have the effect of increasing
our operating expenses, thereby affecting our operating income. The extent of
this effect on our operating income depends on the rate of inflation in
Israel.




The
value of our securities portfolio may be adversely affected by a change in the
capital markets, interest rates or the status of the companies in whose
securities we have invested.





As of
December 31, 2008, we held NIS 172 million in Israeli corporate and government
bonds at fixed interest rates, a portion of which is linked to the Israeli
CPI.  Therefore, a decrease in the market value of these bonds or
interest rates or a change in the status of the companies in whose bonds we have
invested could lead to a material increase in our net financing
expenses.




Damage
to our reputation may have a material adverse effect on our operating
results.




Our brand
names, including some of our store format brands, are among the most well
recognizable brands in Israel.  For example, according to internal
surveys, the Mega brand is one of the most prominent and well-known brands in
Israel. Damage to our reputation or to the reputation of our store format brands
due to reports in the media or otherwise may have material adverse effect on our
level of sales with a corresponding impact on our profitability and operating
results.




We
are dependent on franchisees who own and operate a large portion of our Bee
Group stores. We have limited control over franchisees, and our financial
results could be negatively impacted by the performance of the
franchisees.





Our 85%
subsidiary, Bee Group, holds and operates through subsidiaries large retail
chains with 247 stores as of May 31, 2009, of which 171 stores of our "Kfar
Hasha'ashuim", "Dr. Baby" and "Rav-Kat", "Sheshet", "All for a Dollar" and
"Naaman" chains, are owned and operated by franchisees.  This store
ownership mix presents a number of drawbacks, such as our limited control over
franchisees and our limited ability to facilitate changes in the ownership and
management of their store.


16


Subject
to the terms of our franchise agreement, franchisees independently operate and
oversee the daily operations of their stores, and they have a significant amount
of flexibility in running their operations. Their employees are not our
employees.  Although we can exercise control over our franchisees and
their store operations to a limited extent through our franchise agreements, the
quality of franchise store operations may be diminished by any number of factors
beyond our control.  Consequently, franchisees may not successfully
operate stores in a manner consistent with our standards and requirements, or
may not hire and train qualified managers and other store personnel. While we
ultimately can take action to terminate franchisees that do not comply with the
standards contained in our franchise agreements, we may not be able to identify
problems and take action quickly enough and, as a result, our image and
reputation may suffer, and our franchise and property revenues could
decline.





In
addition, our franchise agreements limit our ability to open new stores in the
vicinity of existing franchised stores, which may limit our ability to expand
our business.





Volatility
of Blue Square’s share and ADS price could adversely affect its
shareholders.




The
market price of Blue Square’s ordinary shares and ADSs could be volatile and
could be subject to fluctuations in response to numerous factors, including the
following:




·
            actual
      or anticipated variations in our quarterly operating results or those of
      our competitors;




·
            changes
      in financial estimates by securities
analysts;




·
            conditions
      or trends in our business;




·
            changes
      in the market valuations of our
competitors;




·
            announcements
      by us or our competitors of significant
  acquisitions;




·
            entry
      into strategic partnerships or joint ventures by us or our
      competitors;




·
            the
      political, economic, security and military conditions in
      Israel;




·
            additions
      or departures of key personnel; and




·
            sales
      of ordinary shares by Blue Square’s controlling
    shareholder.




Many of
these factors are beyond our control and may materially adversely affect the
market price of Blue Square’s ordinary shares and ADSs, regardless of our
performance.




Since
1996, Blue Square’s ADSs have been listed for trading on the New York Stock
Exchange.  Since November 2000, Blue Square’s ordinary shares have
also been listed for trading on the Tel Aviv Stock
Exchange.  Volatility of the price of Blue Square’s securities on
either market is likely to be reflected in the price of Blue Square’s securities
on the other market.  In addition, fluctuations in the exchange rate
between the NIS and the dollar may affect the price of Blue Square’s ordinary
shares on the Tel Aviv Stock Exchange and, as a result, may affect the market
price of Blue Square’s ADSs on the New York Stock Exchange.




17




Currency fluctuations might affect
our operating results and translation of operating results.





Any
devaluation of the NIS against various non-Israeli currencies in which we or our
suppliers pay for imported goods has the effect of increasing the selling price
of those products which we sell in Israel in NIS and affecting our operating
results.  This devaluation would have a greater affect on our non-food
retail business because a higher proportion of the goods that we sell in our Bee
Group stores are acquired from suppliers overseas.  This devaluation
would also cause an increase in our expenses as recorded in our NIS denominated
financial results even though the expenses denominated in non-Israeli currencies
will remain unchanged.





In
addition, because our financial results are denominated in NIS and are
translated into US dollars for the convenience of US investors, currency
fluctuations of the NIS against the US dollar may impact our US dollar
translated financial results.





Our
profit margin would be adversely affected if our ability to utilize our
distribution centers were limited.





We have a distribution center in Rishon
Letzion from which we distribute to our supermarkets a large portion of the
products they carry. The products distributed by our distribution center to our
supermarkets generated approximately 21% of our total percentage purchases
during 2008.  In addition, in the coming years we intend to open two
new distribution centers, one for fruits and vegetables and one for non-food
sold in our supermarkets and by Bee Group. Our inability to utilize the
distribution centers for any reason may significantly impair our ability to
distribute our products to our supermarkets and would adversely affect our
profit margin.





We
are exposed to risks of fraud and theft with regard to our gift certificates
which may cause a loss of revenue and non-recoverable expenses.




We run
programs under which we issue and sell gift certificates and electronic prepaid
cards to institutions, companies and individuals, particularly during the High
Holiday and Passover seasons.  The gift certificates and prepaid cards
can be used in our stores as well as other stores with which we entered into
collaboration agreements.  We are exposed to risks connected with the
issuance of gift certificates, including risks that they may be fraudulently
forged or stolen, and we are exposed to risks of computer fraud or errors in
connection with the issuance of prepaid cards.  A substantial or large
scale forgery, theft, fraud or error may cause a reduction in our revenue and
increase our expenses.




18




The
potential declaration of a boycott by certain segments of Israel’s
ultra-orthodox population against our Shefa Shuk stores may affect our financial
results.




Since the
second half of March 2008, the media has published reports that certain segments
of Israel’s ultra-orthodox population are considering the declaration of a
boycott against our Shefa Shuk stores due to the operation of stores owned by
our controlling shareholder on the Jewish sabbath.  Although the
Company is unaware of any public declaration of a boycott, since the end of
March 2008, the Company has experienced a significant decrease in the sales of
several Shefa Shuk stores which appeal to the ultra-orthodox community and/or
are located within ultra-orthodox neighborhoods. During 2008 and with the
launching of "Mega Bool" chain at the end of 2008, we have converted most of our
Shefa Shuk stores to "Mega in Town" and "Mega Bool" stores. As of May 31, 2009,
we operated 18 Shefa Shuk stores compared to 44 as of December 31,
2007.  An actual declaration of a boycott may adversely affect the
company's financial results.




We
may be limited in our ability to borrow from Israeli banks.




Bank of
Israel regulations limit the ability of Israeli banks to lend to various
borrowers over certain limits, including to companies and individuals considered
to be in an affiliated group. These regulations limit the amount available to us
and to our group companies to borrow from Israeli banks.  For purposes
of these regulations, we are considered part of one borrowing group with the
Alon group and, to the Company's knowledge, with the Africa Israel group (an
interested party in Alon), and we may be considered part of one borrowing group
with other members of our controlling shareholders group and/or, under certain
circumstances, with interested parties in the group, including Alon Retail, and
other corporations under control of the Alon group and the Africa Israel
group.  As a result of these regulations, some Israeli Banks are
prevented from providing additional credit to companies within our "borrowing
group", and we and our subsidiaries may face limitations from time to time in
our ability to obtain additional credit from Israeli banks.  This
could adversely affect our ability to operate our business as we have in the
past.




The
failure of our use of technological information systems and computer systems may
adversely affect our day-to-day operations.




We use
several technological information systems and computer systems.  Our
day-to-day operations are dependent on the proper function of these
systems.  We take various measures to ensure the integrity and
reliability of the data and computer systems, including data protection and data
back up.  However, a failure of our data and/or computer systems may
adversely affect our day-to-day operations.




19




We
are party to legal proceedings in connection with tax assessments.




In July
2005, the Income Tax Authority issued a notice of a deduction assessment for the
years 2001-2004 to the Company. The amount claimed under these assessments
totaled NIS 34 million, and primarily relates to certain benefits granted
to employees in the Company’s branches. In November 2005, several senior
employees were questioned under warning, with respect to these
benefits.  Following these assessments and after the rejection of the
Company's position on the matter, the Income Tax Authority issued to the Company
deduction assessment orders for the years 2001-2004 in the amounts of
approximately NIS 44 million. The Company has filed appeals with the District
Court contesting these assessment orders, which as of the date of this Annual
Report are still pending. In July 2007, the Israeli Tax Authority issued to the
Company value added tax assessment for the years 2001-2006 in the amounts of
approximately NIS 22 million in connection with the subject matter of the
foregoing deduction assessments. The Israeli Tax Authority did not accept most
of the Company's position, although it agreed toreduce the total amount
to approximately NIS 16.3 million.  On February 29, 2009, the Company
filed an appeal with the District Court, which as of the date of this Annual
Report is still pending.  In the opinion of the Company and its
advisors, the provisions included in the Company financial statements are
sufficient to cover the potential liabilities.




Political
conditions in Israel affect our operations and may limit our ability to sell our
products.




We and
all of our subsidiaries are incorporated under Israeli law and our principal
offices and operations are located in the State of Israel.  Political,
economic, security 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 a state of hostility, varying, from time to time, in intensity and degree,
has led to security and economic problems for Israel. We could be adversely
affected by hostilities involving Israel, the interruption or curtailment of
trade between Israel and its trading partners, a significant increase in
inflation, or a significant downturn in the economic or financial condition of
Israel.




The
future of Israel’s relations with its Arab neighbors and the Palestinians is
uncertain, and several countries, companies and organizations continue to
restrict business with Israel and with Israeli companies.  We could be
adversely affected by adverse developments in Israel’s relationship with its
Arab neighbors and the Palestinians or by restrictive laws, policies or
practices directed towards Israel or Israeli businesses.




In the
last few years, the establishment of a Hamas government in Gaza has created
additional unrest and uncertainty in the region and has increased hostilities
between Israel and the Palestinians. These hostilities have included terrorist
acts in Israel and military operations in the West Bank and Gaza. In December
2008 Israel was engaged in an armed conflict with Hamas in the Gaza Strip, which
reduced the sales of some of our stores that are located in the southern region
of Israel. In July 2006, a conflict with Hezbollah escalated significantly on
Israel’s northern border.  Due to the hostilities in the northern part
of Israel and Lebanon, a number of our stores located in the northern region did
not operate according to their usual schedule. We cannot predict the effect on
our business if hostilities are renewed or the security situation deteriorates
in any part of the country.




Many of
our officers and employees are currently obligated to perform annual reserve
duty and are subject to being called to active duty at any time under emergency
circumstances.  We cannot assess the full impact of these requirements
on our workforce or business if conditions should change, and we cannot predict
the effect on us of any expansion or reduction of these
obligations.




20




Disruptions
of the Israeli ports may affect our ability to import products used in our Bee
Group business.





The Bee
Group acquires most of its products from suppliers outside of Israel, and most
of its products are imported via the sea. A prolonged general strike, shutdown
or a disruption of any of the Israeli ports for an extended period of time,
including as a result of a military conflict, would affect our ability to import
such products or increase their prices. In addition, since the peak selling
season of some of our Bee Group stores is during the holidays, disruptions in
the ports during or adjacent to such holiday seasons may adversely affect our
sales and financial results.




Political
and economic conditions in China may affect the operating results of the Bee
Group.





Most of
Bee Group's imports during 2008 were from suppliers located in
China.  Because most of the products sold by the Bee Group are
manufactured overseas and imported from China, its activity may be affected by
changes in the political and economic conditions in China.  For
instance, any material change in the NIS-Chinese currency exchange rate may
increase our manufacturing costs and increase the price of those imported
products from China.




Our
imports from China are affected by costs and risks inherent in doing business in
Chinese markets, including, changes in regulatory requirements or tax laws,
export restrictions, quotas, tariffs and other trade barriers, and general
economic problems.





Any of
these risks could have a material adverse effect on our ability to deliver or
receive non-food products on a competitive and timely basis and on our sales and
profitability.




Government-imposed
price controls may have a material adverse effect on our operating
results.




The
Israeli government is authorized to control the retail and wholesale prices of
goods and services offered in Israel.  At present, a few of the
products we offer in our stores, including bread, flour, eggs, milk and
margarine are subject to government-imposed price controls.  In
addition, during periods of high inflation in the past, more extensive price
controls have been imposed throughout Israel.




We do not
believe that current price controls haveany material adverse
effect on our business or operating results. However, any imposition of
more extensive price controls in the future may have a material adverse effect
on our operating results.  We cannot assure you that broader price
controls will not be imposed in the future.




21




It
may be difficult to enforce a U.S. judgment against us and some of our officers
and directors, to assert U.S. securities laws claims in Israel or serve process
on our officers and directors.




We are
incorporated in Israel.  Our executive officers and directors are
nonresidents of the United States, and substantially allof our assets and most of 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 U.S.
federal securities laws against us or any of these non-residents of the United
States or to effect service of process upon these persons in the United
States.  Additionally, it may be difficult for you to enforce civil
liabilities under U.S. federal securities laws in actions instituted in
Israel.




Risks
Relating to Real Estate





We
are subject to risks regarding the ownership of real estate assets.





We own,
through our subsidiaries, real-estate assets, most of which are currently used
in connection with the retail operation of our stores, and the remainder is
leased to third parties or for future development. These assets are subject to
risks with regard to ownership of real-estate assets, including decline in
demand and surplus of supply of commercial properties, which might have a
material adverse effect on the real-estate markets, occupancy rates, rental fees
and revenues from third parties and on the value of the assets in the Company's
financial statements. These risks include increase of operational costs, decline
of the financial conditions of the lessees and additional factors which are
beyond our control.




The
slowdown in the Israeli yield-generating real estate market may adversely affect
our business.




In the
beginning of the fourth quarter of 2008 and as a result of the global economic
and financial market crisis, there has been a slowdown in the Israeli
yield-generating real estate market which is evidenced by a decline in the
number of real estate transactions, a reduction in the availability of credit
sources, an increase in financing costs and stricter requirements by banks for
providing such financing.  In the last few months, the Israeli market
has also been affected by the volatility in exchange rates of principal
currencies versus the NIS and the volatility of inflation rates within the local
market.   If the economic conditions in Israel
continue,  there may be a continued decline in demand for commercial
real estate, a reduction in rental fees, a decline in the fair value of our real
estate assets and an increase in the cost and availability of financing from
Israeli banks, which could adversely affect our real estate
business.




22




BSRE
may not be able to obtain additional financing for its future capital needs on
favorable terms, or at all, which could limit its growth and increase its costs
and could adversely affect the price of its ordinary shares.





BSRE's
activities are financed from external sources, and an adverse change in the
terms of the financing that it receives (or its inability to obtain financing)
could result in a material adverse effect on the results of the Company and its
ability to develop its real estate business. As of December 31, 2008, BSRE had
approximately NIS 32.8 million in loans that had been transferred to it as a
part of the transfer of real estate assets from BSI to BSRE.  These
loans were transferred by BSI without any change in the terms of these
loans.  We cannot be certain that the BSRE will be able to obtain
additional financing on at least the same terms as the loans that were
transferred to it by BSI, or at all, and BSRE cannot be certain that its
existing credit facilities will be renewed.  This could increase
BSRE's financing costs and inhibit BSRE's long-term expansion
plans.  In addition, the completion of the transfer of real estate
properties from BSIP to BSRE requires a significant financing and is expected to
increase the financing expenses of BSRE.





ITEM
      4.
            INFORMATION
      ON THE COMPANY




A.              History
and Development of Blue Square.




Blue
Square-Israel Ltd. was incorporated in June 1988 as a company under the
laws of the State of Israel.  Blue Square’s principal executive
offices are located at 2 Hamal Street, Rosh Ha’ayin 48092, Israel and its
telephone number is 972-3-928-2222.




In 1996,
Blue Square completed its initial public offering and its ADSs were listed for
trading on the New York Stock Exchange.  In November 2000, Blue
Square’s ordinary shares were listed for trading on the Tel Aviv Stock
Exchange.




Developments
of Blue Square During 2008




In
September 2008, we acquired an additional 25% of the shares of Bee Group Retail
Ltd. ("Bee Group"), a company that operates (mostly through franchisees) retail
outlets with activities in the houseware and home textile, toys, leisure and
baby and young children sectors, for consideration of NIS 35.4 million ($9.8
million at that time), increasing our holdings in Bee Group to 85%. Under the
share purchase agreement, we also have a call option to purchase the remaining
15% of Bee Group's shares from other Bee Group shareholders during the five-year
period from the closing, and the sellers of these remaining shares have a put
option to sell their shares to us commencing 24 months from the closing date for
a period of 30 days at the same price as the call option.  The
exercise price is subject to adjustment in the event that Bee Group completes an
initial public offering of its shares during the three years from
closing.  For a description of the share purchase agreement for Bee
Group's shares, please see “Item 10.  Additional Information – C.
Material Contracts”.




In
November 2008, pursuant to a cash tender offer, we completed the acquisition of
the BSIP shares that were not previously held by us, for the aggregate
consideration of NIS 150.7 million ($40.2 million at that time). We currently
own 100% of the shares of BSIP, and BSIP's shares are no longer traded on the
Tel-Aviv Stock Exchange.




23




In
December 2008 and January 2009, our board of directors approved a reorganization
of our supermarket retail and real estate activities pursuant to which our
supermarket retail activities are centralized in BSIP, and Blue Square's real
estate activities are to be centralized in Blue Square's subsidiary,
BSRE.  In addition, as part of the reorganization of the retail
activities, BSIP is to merge with its wholly owned subsidiary, The Blue Square
Chain (Hyper Hyper) Ltd. ("Hyper Hyper"), as a tax exempt transaction, and all
of the retail activity of Hyper Hyper is to be transferred to
BSIP.  BSRE's shareholders approved the reorganization of the real
estate activities at BSRE's extraordinary general shareholder meeting held on
February 18, 2009.  As a result of ongoing discussions between BSIP
and BSRE and the Israeli Tax Authority regarding the structure of the real
estate reorganization, BSRE's board of directors may amend the terms of the
transaction until August 19, 2009, and such amendment will be subject to BSRE
shareholder approval, if it is material. If BSRE's board of directors does not
amend the terms of the transaction by August 19, 2009, or if the amended terms
of the transaction are not approved by BSRE's shareholders, then the transaction
will be effected according to its original terms.  For a description
of Blue Square's supermarket retail and real estate activities reorganization,
please see “Item 7.  Major Shareholders and Related Party Transactions
- B. Related Party Transactions”.




The
following is a description of certain events that have occurred during the last
number of years:




·
            Changes
      in our store formats, including:




·
            The
      launch of "Mega Bool", a hard discount store format.  As of May
      31, 2009, this initiative included the conversion of 40 existing "Mega"
      and "Shefa-Shuk" stores of various sizes to the new
  brand;




·
            The
      launch of “Mega In Town”, a discount supermarket brand designed to combine
      discount prices and convenience for neighborhood shoppers. As of May 31,
      2009, we had 115 “Mega In Town” stores; this initiative has included the
      conversion of over 100 existing SuperCenter and Mega stores to the new
      brand; and




·
            The
      entering into the organic/health food market by acquiring the control
      interest in Eden Briut Teva Market ("Eden Nature"), which as of May 31,
      2009, operated seven organic/health food
  supermarkets;




·
            The
      launch of a private label called "Mega", that was expanded throughout our
      "Mega Bool", "Mega in Town" and "Mega" store formats beginning on December
      2008.  We intend to broaden the variety of products offered
      under the private label during 2009 and
onwards;




·
            As
      part of our strategy to expand our presence in “Non-Food” stand alone
      retail outlets, we acquired 50% of Bee Group in 2005, and by 2008 we had
      increased our holdings in Bee Group to 85%.  Concurrently, Bee
      Group acquired the controlling interest in Vardinon Textile Ltd. (home
      textile retailer and wholesaler) and the controlling interest in Naaman
      Porcelain Ltd. (houseware retailer and
  wholesaler);




24




·
            The
      reorganization of our real estate assets, including the transfer of all
      related rights and obligations and certain liabilities (including lease
      agreements of which we were lessor and BSIP or third parties were lessees)
      to BSRE, a then new wholly owned subsidiary.  In addition, our
      board of directors and the shareholders of BSRE have approved the transfer
      of all of the real estate held by our wholly-owned subsidiary, BSIP, and
      its subsidiaries to BSRE.  We are discussing the structure of
      this transaction with the Israeli Tax Authority;
  and




·
            The
      establishment of a joint loyalty plan (the "You Plan") with Dor Alon
      Energy In Israel (1988) Ltd. in 2005, including the offering to our
      customers of a Diners Club Israel credit card bearing the name “You”, and
      the acquisition, together with Dor Alon, of 49% of the shares of Diners
      Club Israel Ltd., a subsidiary of Credit Cards for Israel Ltd. (allocated
      36.75% to us and 12.25% to Dor Alon), the launching in 2009 of a new "You"
      Mastercard credit card and the planned expansion in 2009 of our customer
      loyalty plan through the offering of a new  membership card (see
      “Item 4. Information on The Company - B. Business Overview -Related
      Businesses”).




Capital
Expenditures




A key
component of our business strategy is the establishment and relocation of new
stores, the remodeling of existing stores and the improvement of our
distribution facilities.  During the three months ended March 31,
2009, we invested approximately NIS 55.7 million, or $13.3 million, in fixed
assets and investment property.  In 2008, we invested approximately
NIS 282 million, or $74.2 million, in fixed assets and investment property,
a 17% increase from our 2007 investment of NIS 241 million. Of our fixed
asset investment and investment property in 2008, we invested NIS 89.5
million, or $23.7 million, in land and buildings, including land that we lease,
as compared with NIS 82.7 million in 2007.  As of
December 31, 2008, we had entered into agreements for investments in
fixtures, equipment and leasehold improvements in an aggregate of NIS 36
million, or $9.4 million.




For
additional information pertaining to our principal capital expenditures and
divestitures for the last three financial years and those of which are currently
in progress, and the method of financing, see “Item 5. Operating and Financial
Review and Prospects - Liquidity and Capital Resources”.






B.              Business
Overview.




General




We are
the second largest food retailer in the State of Israel.  We also
operate in the "Non-Food" sector, selling “Non-Food” items both in our
supermarkets and in stand alone retail outlets. We also operate in the
yield-generating commercial real estate sector, in which we own, lease and
develop yield-generating commercial properties.




25




As of the
date of this Annual Report, we have 199 supermarkets with brands including "Mega
Bool", "Mega In Town", "Mega", "Shefa Shuk", "Eden Nature".  In
addition, we have 247 non-food retail outlets (partly through franchisees) under
the control of our subsidiary, Bee Group Retail Ltd. ("Bee Group") under the
brand names Naaman, Vardinon, Sheshet, Kfar Hasha’ashuim, Rav-Kat, Dr. Baby and
All for a Dollar.  Through our supermarkets, we offer a wide range of
food and beverages products and also “Non-Food” items, such as houseware, toys,
home textile products, small electrical appliances, computers and computer
accessories, entertainment and leisure products, and “Near-Food” products, such
as health and beauty aids, infants products, cosmetics and hygiene
products.  We also operate several toy and housewares departments
within most of our large stores.   Through our stand alone
"Non-Food" retail outlets, we offer a range of houseware and home textile, toys,
leisure and baby and young children products.




Our
activities are carried out via our consolidated subsidiaries, the largest of
which are BSIP, which has supermarket retail activities, Bee Group, which
conducts non-food retail activities, and BSRE, which owns and invests in
commercial real estate.  As of June 15, 2009, Blue Square owned 100%
of the outstanding shares of BSIP, 85% of the outstanding shares of Bee Group,
and 78.45% of the outstanding shares of BSRE. The balance of BSRE shares is
publicly held and traded on the Tel Aviv Stock Exchange.




Following
the reorganization of Blue Square's supermarket retail activities pursuant to
which Blue Square's supermarket retail activities were transferred to BSIP, BSIP
and its direct and indirect subsidiaries are the owners of all 194 of our
supermarkets.  As of December 31, 2008, the total consolidated
assets of BSIP and its subsidiaries aggregated approximately NIS 1.4 billion, or
$379 million, constituting approximately 32.4% of our total consolidated assets
at that date.




BSRE has
no retail activities; BSRE's revenues are primarily derived from real estate
lease payments received from BSIP and third parties. As of December 31,
2008, the total consolidated assets of BSRE aggregated approximately NIS 1.4
billion, or $385.4 million, constituting approximately 33% of our total
consolidated assets at that date.




As of May
31, 2009, Bee Group and its direct and indirect subsidiaries are the owners of
76 of our non-food retail stores, while the remaining 171 of our non-food retail
stores are owned and operated by franchisees of Bee Group and its
subsidiaries.  As of December 31, 2008, the total consolidated
assets of Bee Group and its subsidiaries (excluding the stores owned and
operated by franchisees) aggregated approximately NIS 459 million, or $120.8
million, constituting approximately 10.3% of our total consolidated assets at
that date.




26




Supermarkets




The
following table sets forth the change in the number of our supermarket stores
(net of store closures) and supermarket store space as of the dates
indicated:




No. of Stores
                            
                            
                            Store Space
                              (square meters)As
      of December 31, 2004
                            
                            164
                            
                            
                            
                            300,000As
      of December 31, 2005
                            
                            168
                            
                            
                            
                            312,000As
      of December 31, 2006
                            
                            175
                            
                            
                            
                            323,000As
      of December 31, 2007
                            
                            185
                            
                            
                            
                            342,705As
      of December 31, 2008
                            
                            194
                            
                            
                            
                            354,531




We have
five supermarket store formats - Mega Bool, Mega, Mega In Town, Shefa Shuk and
Eden Nature. Our "Mega Bool" chain stores are hard discount stores designed to
provide customers with name brand quality at everyday affordable prices. In the
“Mega” chain stores, our larger stores which are located primarily outside
residential areas, we offer a wide selection of food, “Near-Food” and “Non-Food”
items.  In the “Mega In Town” chain stores, the stores are usually
smaller than “Mega” stores, located primarily in local neighborhoods and city
centers, and combine discount prices with convenience for neighborhood shoppers.
Our “Shefa Shuk” chain stores are low priced stores oriented towards Israel’s
growing ultra-orthodox population. In our "Eden Nature" stores, we focus on
offering organic, natural and health food products.  As of December
31, 2008, we operated 19 Mega Stores, consisting of approximately 69,768 square
meters space, 113 Mega In Town stores, consisting of approximately 122,784
square meters space, 36 Mega Bool stores, consisting of approximately 118,229
square meters space, 21 Shefa Shuk stores, consisting of approximately 36,473
square meters space, and 5 Eden Nature stores, consisting of 7,277 square
meters.




In
August, 2007, we launched our “Mega In Town” supermarket format designed to
bring discount shopping to the neighborhood and city centers. The initiative
included the conversion of over 100 of our existing SuperCenter and Mega stores
to the new brand. “Mega In Town” is a discount supermarket brand designed to
combine discount prices and convenience for neighborhood shoppers. “Mega In
Town” stores are differentiated by their reduced prices, narrowing the gap
between them and those of Hard Discount centers located in peripheral areas. In
addition, such stores offer a greater variety of items than were previously
carried by SuperCenters and Megas in residential areas.




On
October 31, 2007, we acquired 51% of the outstanding shares of Eden Briut Teva
Market Ltd. (“Eden Nature”) for a total consideration of approximately NIS 22.5
million.  Eden Nature is one of Israel’s largest retailers of organic,
natural and health food products, operating seven supermarket stores as of May
31, 2009, specializing in organic, natural and health food products. As part of
this transaction, (i) we provided Eden Nature with shareholder loans in the
amount of NIS 47 million, (ii) we have the right to appoint a majority of the
board of directors and a majority of the executive committee of Eden Nature,
(iii) the other shareholder has the various minority protection rights, and (iv)
we are to provide all guarantees and financing required in connection with Eden
Nature’s operations in the future, the repayment of existing shareholder loans
in the amount of NIS 4.7 million, which has since been repaid, and the payment
of a bonus to Eden Nature’s CEO upon the satisfaction of various thresholds
which have not yet been satisfied.




27




In
December 2008, we launched our "Mega Bool" hard discount store format, designed
to provide customers with name brand quality at everyday affordable prices, in
response to an increase in consumer preference for hard discount stores that we
have identified in the recent years.  As of May 31, 2009, the
initiative included the conversion of 40 of our existing stores of various sizes
to the new brand, including large stores from the "Mega" and "Shefa Shuk"
formats and smaller stores located within residential neighborhoods and city
centers.




In
parallel, we also announced the launch of our new "Mega" line of private label
goods that are sold in our "Mega Bool", "Mega", and "Mega In Town"
stores.  Private label products provide customers with an attractive
alternative selection of products that are comparable in quality to name brand
products.  We believe that our private label products enhance customer
loyalty, differentiate our stores from those of our competitors and provide a
competitive product to those offered by our suppliers.  In addition,
usually the average gross profit from private label products is higher than the
average gross profit from other products.




Non-Food
Retail





As of May
31, 2009 we operated, through Bee Group, its subsidiaries and franchisees, a
total of 247 non-food retail stores, 171 of which are operated by
franchisees.





As part
of our strategy to increase our market share of “Non-Food” and “Near-Food”
products and to offer a wider selection of these products to consumers in our
stores, in May 2005, we acquired 50% of the holdings of Bee Group Retail Ltd.
(formerly known as “Hamachsan Hamerkazi Kfar Hasha’ashuim Ltd. (Central
Warehouse/Toy Village)”("Bee Group"), in April 2007, we increased our holdings
in Bee Group to 60%, and in September 2008, we increased our holdings in Bee
Group to 85%.




Bee Group
holds and operates through subsidiaries large retail chains in Israel of
houseware and home textile, toys, leisure and baby and young
children stores, with 247 stores, located throughout Israel, owned and
operated mostly by franchisees as of May 31, 2009.  The chain operates
under a number of different brand names: (i) "Naaman", which sells houseware
products; (ii) "Vardinon", which sells home textile products and accompanying
accessories; (iii) "Sheshet", which sells houseware and small electrical
appliances; (iv) "Kfar Hasha’ashuim" (Toy Village), which sells toys; (v)
"Rav-Kat" and Dr. Baby, which sells baby and young children accessories; and
(vi) “All for a Dollar".  The stores of our "Naaman", "Vardinon" and
"Dr. Baby" chains are primarily owned and operated by us, while the stores of
our "Kfar Hasha'ashuim", "Sheshet" and "All for a Dollar" chains are primarily
owned and operated by franchisees. In addition to these stores, we have
established toy and houseware departments within most of our large supermarket
stores.




28




On April
22, 2007, Bee Group acquired approximately 85.8% of the share capital of
Vardinon Textile Ltd. ("Vardinon") a company traded on the Tel Aviv Stock
Exchange for a total consideration of approximately NIS 38 million. Vardinon
imports, designs and distributes home textile products and accompanying
accessories, such as linen, towels and bathrobes under the brand name "Vardinon"
and other products such as blankets, bed covers, curtains, pillows, other
houseware products, candles and spa products. The products are distributed by
Vardinon's chain of retail stores (36 stores as of May 31, 2009) and by
wholesale to customers that include other wholesalers, retail chains, employee
committees and catalogues. In January 2008, we entered into a supply agreement
with Vardinon pursuant to which Vardinon is to supply us with a variety of
textile products manufactured by Vardinon under a new private label, which are
to be designed by us in collaboration with Vardinon.




On
October 31, 2007, Bee Group acquired 57.87% of the outstanding shares of Naaman
Porcelain (51.5% on a fully diluted basis) ("Naaman"), a company traded on the
Tel Aviv Stock Exchange, for a total consideration of approximately NIS 101
million.  Naaman is one of Israel’s major branded houseware retailers
which imports and markets various houseware products, such as kitchen utensils,
cutlery and dinner sets. As of May 31, 2009, Naaman had its own chain of 27
houseware stores, five of which are operated by franchisees, and is a supplier
to BSIP.  Naaman also sells its products to wholesale customers,
including privately owned stores, retail chains, institutional customers,
employee committees and sales promotion companies.




On August
11, 2008, Bee Group and the other Sheshet shareholders contributed to Naaman all
of the shares in "Sheshet" in exchange for shares in Naaman. In addition, on
September 25, 2008, Bee Group contributed to Naaman all of Bee Group's interest
in Vardinon (approximately 84.79% voting power and 67.98% of the share capital,
at that time) in exchange for approximately NIS 36.9 million in
cash.  On March 22, 2009, Bee Group acquired an additional
approximately 8% of the shares of Naaman for cash.  Following all of
these transactions, Bee Group's holdings in Naaman were increased to
approximately 66.85% of the outstanding shares. On June 1, 2009 Naaman acquired
an additional approximately 3% of the shares of Vardinon. As a result of this
acquisition, Naaman increased its holding in Vardinon to approximately 88.74% of
the voting power and 71.15% of the share capital.




Industry
Overview




Supermarkets




We
estimate that retail sales of food, beverages and tobacco in Israel were
approximately NIS 54.2 billion, or $14.3 billion, in 2008.  This
estimate is based on the data published by the Israeli Central Bureau of
Statistics of the retail sales of food, drinks and tobacco in Israel in 2007
(2008 has not yet been published) and the growth of expenditure for the
consumption of food, beverages and tobacco of household in Israel at current
prices in 2008 (9.9%).




29




The
retail sales of food, beverages and tobacco in Israel includes supermarkets,
grocery stores, mini-markets and retail sales of fruit and vegetables, meat,
poultry and fish. The supermarket retail chain market consists of two large
chains: Shufersal and us, as well as other smaller but developing
chains.




Based on
A.C. Nielsen and on data published by the Israeli Central Bureau of Statistics
of the retail sales of food, drinks and tobacco in Israel, we estimate that
approximately 37% of the total retail sales of food, beverages and tobacco in
Israel in 2008 was made by the two large chains and approximately 46% of the
estimated retail sales made by supermarkets, groceries and mini-markets in
Israel in 2008 was made by the two large chains - a percentage that is
considerably lower than the estimated market shares prevailing in Europe and the
United States.  Accordingly, we believe that there is an opportunity
for us to grow correspondingly with the general growth of the supermarket sector
in Israel.




Non-Food
Retail




The
non-food retail sales of houseware in Israel includes houseware departments in
large retail chains, do-it-yourself retail chains, and private specialty stores
and boutiques.  The sale of these products through catalogs and
internet sites has also increased in recent years.  We do not have
enough information to assess our market share in this market, as most of our
competitors are privately owned companies.




The
non-food retail sales of home textile in Israel includes home textile
departments in large retail chains, department stores and private
stores.  There are also many companies and distributors that market
and sell home textile products to wholesale customers.  We do not have
any formal information about the size of the home textile market and the market
share of the various competitors in this market; however, we estimate that our
"Vardinon" chain is one of the leading retailers in the premium home textile
market.




The
non-food retail sales of baby products and toys in Israel includes mainly
smaller privately owned stores. We do not have enough information to assess our
market share in these markets, as most of our competitors are privately owned
companies.




Yield-Generating Real
Estate




The
yield-generating real estate market in Israel includes the development,
promotion, planning, construction, marketing and operating of real estate
properties intended for leasing primarily for the purpose of commercial,
industrial, office space, parking garage and warehouse use. The yield-generating
real estate market is affected by growth or slowdown in the Israeli economy, and
by changes in the demand and the available supply of commercial areas, as well
as the construction of additional commercial areas.  The real estate
market is also affected by governmental, municipal and tax authority policies
regarding planning, building, marketing and taxation of
land.  Beginning in the fourth quarter of 2008 and as a result of the
global economic and financial market crisis, there has been a slowdown in the
Israeli yield-generating real estate market which is evidenced by a decline in
the number of real estate transactions, a reduction in the availability of
credit sources, an increase in financing costs and stricter requirements by
banks for providing such financing.  However, as most of our
yield-generating real estate is leased for our supermarkets, we believe that we
have limited exposure to the effects of the slowdown in the Israeli
yield-generating real estate market.




30




Seasonality




Our
business is subject to fluctuations in quarterly sales and
profits.  These fluctuations are primarily attributable to increased
sales and higher operating income in the holiday seasons occurring in different
quarters from year to year.  Thus, for example, in our supermarkets
and in our "Naaman", "Vardinon" and "Sheshet" chains increased sales
attributable to Passover, which occurs in either March or April, may be
realized in either the first or the second quarter, and sales attributable to
the Jewish New Year, which occurs in either September or October, may be
realized in our financial reports in either the third or the fourth
quarter.  In our "Kfar Hasha'ashuim" chain, increased sales are
generally attributable to Purim, which occurs in March, and to the
"Back-to-School" season in August.  Generally, purchases for a
particular holiday occur during the two-week period prior to the commencement of
that holiday.  However, the timing of the holidays does not affect our
semiannual results.




Many of
our expenses are unrelated to the level of sales, and therefore a relatively
modest increase or decrease in sales, whether or not related to the timing of
holidays, tends to have a disproportionately large impact on our
profitability.




Our Strategy




Our
strategy in our retail activities is: (i) to take advantage of our position as a
leading food retailer in Israel, by expanding our market presence in existing
retail food markets and (ii) to capitalize on potential synergies and our
internal reorganization in order to improve our operating efficiency. To achieve
this goal, we intend to pursue a number of operating and growth strategies,
which include:




·
            increasing
      the pace of our growth rate and market share by opening additional store
      locations, renovating, improving and enlarging existing stores, adjusting
      our store formats to the needs of our customers and, if necessary,
      reducing and/or closing underperforming
stores;


·
            expanding
      the geographic presence of our stores with the goal of bringing our
      supermarket store formats within the shopping range of every Israeli
      consumer;


·
            increasing
      our market share of “Non-Food” and “Near-Food” products and capitalizing
      on potential operating synergies between the Bee Group and the Company as
      a whole;


·
            solidifying
      and expanding our market share in the organic/health food market with the
      goal of establishing Blue square as a leader of Israel emerging
      organic/health food market.


·
            expanding
      our "Mega" private label line to encompass additional product categories
      and increasing the percentage of our sales from our private label line,
      and thus differentiating our store brands and products from those of our
      competitors;




31




·
            increasing
      operational efficiency, including by improving our distribution
      capabilities and IT systems;


·
            focusing
      on improving the availability of products in our stores and reducing the
      shortage of products “on the shelves”;
and


·
            expanding
      and improving our loyalty plan, which currently offers a new credit card,
      through the offering of a new membership card, including joining
      other businesses to the plan.




Our
strategy in our real estate activities is to become a substantial owner of
yield-generating properties and developer of commercial real estate through our
subsidiary, BSRE.  To achieve this goal, we intend to pursue a number
of operating and growth strategies, which include:




·
            developing
      and improving existing real estate;


·
            maximize
      the leasing of existing properties to commercial
  users;


·
            increase
      and develop unused building rights in our existing properties;
      and


·
            acquire
      additional commercial real estate and yield-generating assets in Israel
      and continue to examine acquisitions abroad in light of market conditions,
      while diversifying our real estate property
  base.





Our Real Estate




Most of
our real estate is currently used in connection with the retail operation of our
stores.




Recent
Activities in Our Real Estate Sector




During
2008, BSRE invested a total amount of NIS 80.4 million, including investments in
rental offices and land in areas used for commercial and industrial
development.




In
addition, we have obtained a building permit and are preparing to begin building
an additional distribution and logistic center, as of May 31, 2009 held 100% by
BSRE, which would be used for storage and distribution of Non-Food and Near-Food
products for our Non Food chains and our supermarket stores. The distribution
center would be operated on a 16,000 square meter site and would be leased to
Bee Group.  Including the initial expense of NIS 19.0 million to
purchase the property, BSRE expects to invest a total of approximately NIS 70
million in building the distribution center.





Transfer
of Real Estate Assets from Blue Square to BSRE




In 2006,
pursuant to and under agreements entered with BSRE on June 21, 2006 (the
"Transfer Agreement") and on April 2, 2006 (the "Split Agreement"), both of
which were effective as of December 31, 2005, the Company transferred its real
estate assets, all related rights and obligations and certain liabilities
(including lease agreements of which the Company was lessor and BSIP or third
parties were lessees) to Blue Square Real Estate Ltd. (BSRE), a then new wholly
owned subsidiary, to manage approximately 146,300 square meters currently
occupied by our stores and other lessees, as well as the unoccupied land and
unused building rights under our ownership.  The transferred assets
did not include: (i) real estate owned by BSIP and its subsidiaries and (ii)
real estate that the Company leases from BSIP or third parties in connection
with our retail activities.  Among the rights transferred were those
pursuant to long term lease agreements, lease agreements, partnership
agreements, purchase agreements, easements and any other agreements between the
Company and third parties relating to the transferred properties (including
certain liabilities to banks for certain credit received by the
Company).




32




Further,
in August 2006, BSRE completed its initial public offering (IPO) of ordinary
shares, unsecured convertible and non-convertible debentures on the Tel Aviv
Stock Exchange.  As a result of the offering, the Company holding in
BSRE was reduced to 80% of the outstanding shares (78.45% as of June 15, 2009).
The balance of BSRE shares is publicly held and traded on the Tel Aviv Stock
Exchange.




For more
information about additional agreements between the Company and BSRE, see “Item
7.  Major Shareholders and Related Party Transactions - B. Related
Party Transactions”.




Tax
Authority Approval of Transfer to BSRE




On May 4,
2006, the Israeli Tax Authority approved our application for a ruling stating
that the transfer of properties to BSRE would receive favorable tax treatment
under the provisions of Sections 104A and 105A(2) and 105(I) to the Income Tax
Ordinance, subject to certain conditions.  In particular, the Israeli
Tax Authority ruled that, assuming compliance with all conditions in the
approval and the related provisions of the Israeli Income Tax Ordinance, there
would be no capital gains or betterment tax, sales tax or, if applicable, stamp
tax in connection with the transfer of the properties to BSRE (and BSRE is to be
charged a reduced 0.5% of the asset value for purchase tax).  The
Israeli Tax Authority agreed with BSRE that the value of the transferred assets
for purchase tax purposes (in the rate of 0.5%) is approximately NIS 1.3
billion.




The tax
approval did not constitute an approval of the principles of allocation of
obligations with respect to the transfer of properties to BSRE between the
Company and BSRE prior to December 31, 2005.  This allocation may be
subject to review by the Israeli Tax Authorities and result in an
adjustment.  If an adjustment is required by the Israeli Tax
Authorities, the Company and BSRE have agreed if additional obligations are
imposed on BSRE, an indemnification arrangement will be implemented providing
that the balance of the equity capital derived to BSRE from the Split Agreement
will not be changed.




The
Israeli Tax Authority approval is one of several permits and approvals necessary
for completing the legal transfer of the assets and recording such assets under
BSRE's ownership.  The Israeli Tax Authority began the process of
issuing tax approvals for the assets that were transferred only after December
31, 2007, until which time the Company and BSRE were required to comply with
certain conditions of the Israeli Tax Authority ruling, as described
below.  BSRE is currently in the process of obtaining the tax
approvals, and as of the date of this Annual Report it has obtained approvals
for the majority of assets that were transferred by the Company.




33




A breach
of the conditions set forth in the Israeli Tax Authority's approval and the
related provisions of the Israeli Income Tax Ordinance may result in the Company
being charged with capital gains or betterment tax and sales tax, and BSRE
being charged for the full rate (5%) of purchase tax (and stamp tax, if
applicable). Based on the Israeli Tax Authority's agreement with BSRE that the
value of the transferred assets for purchase tax purposes is approximately NIS
1.3 billion, the full rate (5%) of purchase tax for the transferred properties
is approximately NIS 65.6 million. Conditions of the Israeli Tax Authority
ruling included the following:





·
            Until
      December 31, 2007, incurred losses (if any) up to the amount of finance
      expenses in connection with loans attributed to the transferred real
      estate and up to the amount of lease expenses of the Company and/or BSRE
      may not be deducted for tax purposes. Thereafter, no such restriction
      applies.




·
            Until
      December 31, 2007, the Company and BSRE may not transfer one to the other
      assets, cash or any other activity except in the ordinary course of
      business. In addition, until December 31, 2010, the Company and BSRE
      may not grant and/or receive loans to each other except in the ordinary
      course of business.




·
            The
      lease payments charged by BSRE for leasing the transferred properties to
      the Company or to any related party of the Company, and the management
      fees charged by the Company to BSRE, will each be at market value as would
      have been obtained in arm's length transactions between non-related
      parties.




·
            In
      accordance with Section 104A of the Israeli Tax Ordinance and in
      connection with the Transfer Agreement, the Company is required to hold at
      least 90% of each kind of right in BSRE until at least December 31, 2007.
      Notwithstanding the foregoing, in the following circumstances prior to
      December 31, 2007, the Company may hold less than 90% of each kind of
      right in BSRE, but in any event not less than 51%: (i) public offer
      pursuant to a prospectus, (ii) private placement of no more than 25% of
      the share capital before the placement and (iii) sale of no more than 10%
      of the ownership rights in BSRE.




·
            In
      accordance with Section 105A(2) of the Israeli Tax Ordinance and in
      connection with the Split Agreement, the Company is required to hold all
      of its rights in BSRE for two years. Notwithstanding the foregoing, the
      following circumstances will not be deemed a change in rights provided
      that until December 31, 2007, the Company may not hold less than 50% of
      the rights in BSRE: (i) public offer pursuant to a prospectus, (ii)
      private placement of shares and (iii) sale of no more than 10% of the
      rights in BSRE.




·
            In
      accordance with the Israeli Tax Ordinance, BSRE is required to hold the
      transferred assets under the Transfer Agreement until December 31,
      2007.




·
            In
      accordance with the Israeli Tax Ordinance, until December 31, 2007, the
      Company is prohibited from selling most of the remaining assets of the
      Company (i.e.,
      which were not transferred under the Split Agreement), and BSRE is
      prohibited from selling most of the assets transferred to BSRE under the
      Split Agreement, and in each case during such period such assets will be
      used for acceptable uses in light of the
  circumstances.




34




A breach
of a condition under the Israeli Tax Ordinance and/or under the tax approval
with respect to one of the transferred properties under the Transfer Agreement
will be deemed only a breach of the transfer of such property and not a breach
of the entire restructuring under the Transfer Agreement. Therefore, in such
case, applicable full tax charges will only be applicable to such
property.




In
addition, in accordance with the Israeli Tax Ordinance, the construction of
buildings on unimproved land transferred to BSRE must be completed within four
years of transfer. To the extent this construction is not completed within this
four year period, which ends on December 31, 2009, the Company and BSRE may
approach the Tax Authority for its determination as to whether such delay
constitutes a default for purposes of the tax benefits. BSRE has not yet
commenced construction of buildings on ten properties on unimproved land
transferred by the Company, and the Company and BSRE are considering, among
other things, to approach the Israeli Tax Authority for an extension on certain
of such ten properties on which it is reasonably likely that construction will
not be completed within the four year period for whatever reason. If
construction on such properties is not completed by December 31, 2009, then the
Company and BSRE may be considered to be in breach of the conditions set forth
in the Israeli Tax Authority's approval and the related provisions of the
Israeli Income Tax Ordinance. Also, the Company and BSRE are examining the
possibility of changing the manner of transfer of these properties to BSRE,
including changing the basis for the tax exemption under the Income Tax
Ordinance. In the event of a breach of the conditions set forth in the Israeli
Tax Authority's approval or a change in the basis of the tax exemption under the
Ordinance, BSRE may be required to pay the additional purchase tax (up to the
rate of 5%), which would impose on BSRE additional tax payments in an estimated
amount of approximately NIS 2 million. For additional information about our real
estate, please see “- D.  Property, Plant and Equipment”
below.




Transfer
of Real Estate Assets from BSIP to BSRE




In
January 2009, Blue Square's board of directors approved a reorganization of its
real estate activities pursuant to which Blue Square's wholly-owned subsidiary,
BSIP, would transfer all of the real estate held by it to BSRE.  On
February 18, 2009, BSRE's shareholders approved the transaction.




As part
of the approved transaction, all real estate property (and related leases) held
by BSIP and BSIP's subsidiaries would be transferred to BSRE.  All
real estate property used by BSIP prior to the transfer would be leased back by
BSRE to BSIP for its retail activities under terms similar to existing lease
agreements between BSRE and BSIP and existing lease agreements between BSRE and
Blue Square that were previously transferred to BSIP, as described below. The
periods of the existing lease agreements would be extended to match the period
of the new lease agreement, i.e., 10 years from the transfer of the BSIP real
estate assets to BSRE, with an additional option period of five years
exercisable by BSIP.




35


The lease
agreements between BSRE and BSIP would contain terms similar to the existing
lease agreements, which provide for annual rent for property used for
supermarkets to be the higher of 2% of the annual turnover of that store or 9%
of the amount paid by BSRE to purchase the underlying real estate of that store
(excluding consideration paid for certain unused building rights), plus amounts
invested by BSRE in the asset, reduced by certain costs and payments and
increased according  to Israel’s CPI. The annual rent for property not
used for stores would be equal to 9% of the amount paid by BSRE, linked to
increases in Israel’s CPI.
 
 The
sale of BSIP's real estate property (and related leases) to BSRE would be for an
aggregate consideration of approximately NIS 464 million, based on an appraisal
by an independent appraiser. BSRE plans to finance approximately 50% of the
consideration from its existing sources and 50% by a financial institution. In
the event BSRE does not obtain the required financing prior to closing of the
transaction, BSRE will be entitled to postpone payment of up to NIS 200 million
of the consideration until April 1, 2010, during which time this amount will
bear interest at 7% per annum and be linked to the Israeli consumer price index.
BSRE is currently engaged in negotiations with a bank to obtain financing for
this transaction. The transaction is subject to various taxes and levies
according to Israeli law which are under examination by BSIP and BSRE and their
advisors. As a result of ongoing discussions between BSIP and BSRE and the
Israeli Tax Authority regarding the structure of the real estate reorganization,
BSRE's board of directors may amend the terms of the transaction up to August
19, 2009, and such amendment will be subject to BSRE shareholder approval, if it
is material.  If BSRE's board of directors does not amend the terms of
the transaction by August 19, 2009, or if the amended terms of the transaction
are not approved by BSRE's shareholders, then the transaction will be effected
according to its original terms.
 
 Description
of Real Estate Properties
  As of
December 31, 2008, the total square meters of developed property that we owned
was approximately 168,000 sq. meters, and the total square meters of undeveloped
property that we owned was approximately 131,000.
  The
following table provides certain details regarding our real estate properties of
which we are the legal owner (including through long-term leases from the Israel
Land Administration), as of December 31, 2008:
  36
  Number
                            
                            
                            Area in sq. m. for
                              leasing (property
                              space)
                            
                            
                            Occupancy rateCommercial
      areas, including supermarket branches
                            
                            
                            103
                            
                            
                            
                            138,029
                            
                            
                            
                            97
                            %Warehouses
      and  Logistics centers
                            
                            
                            2
                            
                            
                            
                            9,013
                            
                            
                            
                            100
                            %Offices
                            
                            
                            3
                            
                            
                            
                            21,025
                            
                            
                            
                            17.3
                            %Total
      developed property
                            
                            
                            108
                            
                            
                            
                            168,067
                            
                            
                            
                            85.1
                            %Total
      undeveloped property
                            
                            
                            15
                            
                            
                            
                            131,000
  Below is
a short description of a number of these properties:
  Commercial
areas, including supermarket branches
 
 The
properties designated for supermarkets are individual units or integrated units
in buildings in industry, residential or commercial areas.  Some of
the properties have parking lots and operational areas that are not included in
the sq. meters calculated for lease.   The majority of the
supermarkets properties are leased to BSI.  Below are the two
commercial areas not designated for supermarkets that BSRE owns:
 
 ·
              Hadar Shopping Mall -BSRE owns 50% of the property, which is located in Talpiot
      industrial area in Jerusalem. The other 50% is held by a third party. The
      lease from the Israel Land Administration ends in 2021 with an option to
      extend the lease for an additional 49 years, subject to a fee. The
      two-floor mall includes 18,000 sq. meters of commercial space, including
      780 parking spots.  The space is leased to third parties,
      including 4,700 sq. meters to Hyper Hyper.  As of May 31, 2009,
      the occupancy rate of the mall is 100%.  The property is managed
      by a joint management company.  BSRE and  the third
      party have applied to the zoning committee for a permit for an additional
      commercial floor above the existing floors of a 9,000 sq. meters, an
      additional upper level parking garage and an additional 6% building rights
      for commercial purposes and additional
floors.
 
 ·
              Property designated for a
      shopping center in Netanya- a 19 dunam property with rights for
      30,000 sq. meters of commercial spaces and offices.  The cost of
      this property was approximately NIS 27 million.  BSRE intends to
      build a shopping mall of approximately 7,500 sq. meters on the first
      floor, as a first stage of development of the property, and BSRE estimates
      that the cost of this first stage of development will be approximately NIS
      50 million and is targeting completion for 24 months from the beginning of
      construction.  However, because BSRE acquired the property in
      the framework of a foreclosure of a mortgage registered on the property,
      BSRE does not currently have an estimate as to the date of the beginning
      of construction because it depends, among other things, on completion of
      existing legal proceedings regarding the status of the
      property.
  37
 
 Offices
 
 BSRE is
the owner of the following three offices building and properties designated for
office building construction:
 
 ·
              Kiryat Arie, Petach
      Tikva- BSRE, owns a property of three office buildings of total
      area of 14,000 sq. meters with rights to build two more stories to the
      existing building. The cost of the acquisition of this property was
      approximately NIS 32 million. BSRE intends to renovate the three buildings
      for office use. BSRE estimates that the additional cost of renovation and
      building of the additional floors would be approximately NIS 30 million
      and is targeting completion for 18 months from the beginning of
      construction. BSRE may delay commencement of construction until after
      marketing some or all of the space.  As of the date of this
      Report, the space in the building has not yet been leased.
      BSRE's  request for additional building rights for two
      additional floors and for construction in connection with the conversion
      of the buildings for office space was recently
  accepted.
 
 ·
              Kiryat Matalon, Petch
      Tikva- in May 2007, BSRE acquired a property with a six story
      office building, with a total area of 2,400 sq. meters, plus an
      underground parking garage with a total area of 1,800 sq. meters. As of
      the date of this Report, the space in the building has not yet been
      leased.
 
 ·
              North Ra'anana– during
      the first quarter 2008, BSRE completed the acquisition of ownership rights
      in an 11 dunam plot designated for commercial and office buildings located
      in the northern industrial area of Ra'anana. In December 2008, BSRE
      acquired additional building rights of the seller. The cost of the
      acquisition of the property was approximately NIS 40 million. The total
      building rights of the property are 20,000 sq. meters for industrial use
      (including commercial and office use), a total of 6,000 sq. meters as a
      services area and some other basements areas. As of the date of this
      Report, on the property there is a 2,000 sq. meter structure leased to
      third party for storage and logistics and a total of 4,000 sq. meters
      leased for a parking lot. BSRE intends to complete the planning of an
      office building on the property containing a total of 20,000 sq. meters
      which would include one commercial floor and an underground parking area.
      In addition, BSRE intends to apply to the zoning committee for a permit
      for the approval of such plans. BSRE is not currently able to
      estimate the amount of time or the scope of the investment that will
      be involved in this project.
 
 38
  Logistics
Areas
  Below is
a short description of the logistic areas owned by BSRE:
 
 ·
              Kibutz Einat – BSRE
      holds 50% of Einat Yield Generating Real Estate Cooperative Ltd. ("Einat
      Ltd."), which has received from Kibbutz Einat its rights to lease a
      property of 26 dunam of industrial use (all of which leased to different
      lessees). The cost of BSRE's share of the rights in this property was
      approximately NIS 24.4 million. The property includes four warehouses
      containing a total of 14,000 sq. meters which are leased to different
      lessees with options to renew. The parties are also waiting for receipt of
      a long term lease from the Israel Land Administration, which would be
      transferred to Einat Ltd. and which has not yet been
    received.
 
 ·
              Be'er Tuvia- BSRE owns,
      through its wholly owned subsidiary Logistic Center Bee Square Real Estate
      Ltd. ("Logistic Center "), a 74 dunam property of which 63 dunam are
      designated for industrial (and storage) areas. BSRE estimates that it has
      rights to build 72,000 sq. meters of commercial areas and office
      buildings. Logistic Center has entered into an agreement with the Bee
      Group to build the distribution center which would be used for storage and
      distribution of Non-Food and Near-Food products for our Non Food chains
      and our supermarket stores. The lease would be for a period of 12 years
      from beginning of use of the property with option to renew for an annual
      payment equal to 9% of the total investment made by Logistic Center in
      acquiring and building this distribution center, linked to the CPI. The
      distribution center would be operated on a 16,000 square meter site and
      would be leased to Bee Group.  Including the initial expense of
      NIS 19.0 million to acquire the property, BSRE expects to invest a total
      of approximately NIS 70 million in building the distribution
      center
 
 ·
              Kibutz Eyal- BSRE and
      Eyl Hasharon, an agriculture cooperative society Ltd. ("Eyal Hasharon"),
      have signed a contract (the "Agreement") regarding the development of a 57
      dunam property for storage and logistics usage. Under the Agreement, BSRE
      and Eyal Hasharon will jointly hold in equal parts a new company to which
      Kibutz Eyal will transfer the property. Closing of the transaction is
      subject to various conditions, including the approval of the Israel Land
      Administration which, as of the date of this Report, has approved the
      transfer of 41 dunam only.  Various other closing conditions
      have also not yet been satisfied. In addition, pursuant to this agreement
      BSRE will transfer to the new company an amount based on the purchasing
      costs, development costs and an additional cost, but not less than $70,000
      per dunam. In the event that the costs exceed $100,000 per dunam, BSRE
      will have the right to terminate the
Agreement.
 
 Properties with development
potential
 
 As of the
date of this Annual Report, BSRE has rights to build a total of 82,000 sq.
meters (74,000 sq. meters mainly for commercial purposes and 8,000 sq. meters
for residential purposes).  Because the utilization of building rights
is dependant on economic feasibility, satisfaction of various conditions,
payment of costs and other factors, it is not clear if and when BSRE would
utilize these building rights.
  39
  Competition
  Supermarkets
  The
Israeli food retailing industry is highly competitive and is characterized by
high turnover and narrow operating margins.  We compete with the other
major supermarket chain, Shufersal, low-priced smaller supermarket chains,
independent grocers, open-air markets, and other retailers selling supermarket
goods. Competitive pressures increase as the supermarket sector in Israel
approaches higher saturation levels and will continue to increase in the event
that our competitors expand their operations or new companies enter the market
with hard discount formats.
  Based on
A.C. Nielsen, we estimate that our market share of the bar-coded market in
Israel in 2008 was approximately 21.4%, Shufersal's market share of the
bar-coded market in Israel in 2008 was approximately 36.9%, and the smaller
supermarkets' market share of the bar-coded market in Israel in 2008 was
approximately 28.0%.
  In recent
years, we and our competitors have established or expanded low-price and hard
discount store formats.  In December 2008 we launched our "Mega Bool"
hard discount store format to address the hard discount store market. In
addition, smaller supermarket chains in 2008 continued to increase their market
share andexpanded
their presence in selected areas in Israel(including by mergers
and acquisitions), often
geographically beyond their original locations. The low barriers of entry,
including the relatively low cost of establishing a new smaller supermarket
chains, have contributed to the increase in number and expansion of smaller
supermarket chains in recent years. These smaller supermarket chains have been
able to capture a significant part of the sales from the major chains in their
areas by using lower cost non-unionized labor and having lower operating costs
and, in some cases, by operating on Saturdays and offering non-kosher
food.  Large supermarket chains in Israel, including us, are kosher
and therefore do not offer non-kosher food or generally operate on
Saturdays.
  Shufersal,
the other major supermarket chain, has taken numerous initiatives in the last
few years to improve its competitive position.  Since 2005, when
Shufersal merged with ClubMarket, the then third major supermarket chain, we
have faced a major competitor, with a broader national presence, especially in
the northern part of Israel where many of ClubMarket stores were
located.  Many of Shufersal's stores are characterized by every day
sale of products at low prices.  The changed competitive position of
Shufersal, together with the expansion of smaller supermarket chains in recent
years, has contributed to the intensifiedcompetition we
experiencedin
recent years, particularly at our larger stores.
  In
November 2005, the Commissioner of the Israeli Antitrust Authority approved
certain arrangements between the Fourth Chain Company Ltd. (“the Fourth Chain”)
and certain smaller supermarket chains.  This approval was granted
subject to certain conditions for an initial period of two years and has since
been extended until February 17, 2011. The Fourth Chain combines a number of
smaller supermarket chains (the “Members”) which operate on local geographic
level and its purpose is to develop a private label and to jointly negotiate
with suppliers. Pursuant to the approved arrangement, the Fourth Chain is
expected to perform the following actions for its Members: to develop and market
a private label which shall be marketed exclusively in the Member stores; to
purchase for the Members complementary services and products; to negotiate with
suppliers from abroad for the import of products for the Members and, in a later
stage, to negotiate prices and commercial conditions with suppliers; to operate
a central joint warehouse; and to sell products to retails other than its
Members. The aforesaid arrangement, and possible similar combinations of other
smaller supermarket chains, may generate some of the efficiencies of a major
national-spread chain and therefore enable them to compete more efficiently with
the major chains.
  40
  In the sale of cosmetic, toiletries and
hygiene products, we compete against establishments that sell such products,
including the drug store chains SuperPharm and NewPharm.
  Non-Food Retail
  In addition, due to our sale of other
“Near-Food” and “Non-Food” products in our supermarkets and in our stand alone
non-food stores, and our acquisitions of controlling interests of “Non-Food”
chains, Bee Group, Vardinon Textile Ltd. and Naaman Porcelain, we also face
competition in the non-food retail market.  In recent years, this
competition has increased primarily due to the entry of retail chains and stores
outside the food industry, such as Toys “R” Us, Office Depot, do-it-yourself
chains such as Home Center and ACE (a franchisee of Ace Hardware), household
stores, home textile stores, houseware stores, electricity appliances stores and
also due to the expansion of the houseware and home textile departments in
supermarkets. This competition affects the sales prices of our products and the
scope of our sales. Increased competition may adversely affect our scope of
sales and our profitability.
 
 In
addition, the barriers of entry are low in some of the markets in which the Bee
Group competes due to the price and availability of products from overseas
suppliers, although the establishment of a network of stores throughout the
country together with the required import and marketing of products, requires a
high level of investment.  The entrance of new competitors may reduce
our market share and may reduce the sale prices of our products and lead to a
reduction in our profitability.
 
 The
merchandise we sell in our non-food retail business through Bee Group is varied,
and we therefore compete in several different markets.
 
 In the
houseware market, in which our "Naaman" and "Sheshet" stores compete, there has
been a consistent increase in competition in recent years, both due to the entry
of the do-it-yourself chains, such as Home Center and Ace, and due to the
expansion of houseware departments within the supermarket retail chains, such as
Shufersal. The sale of these products through catalogs and internet sites has
also increased in recent years.  We do not have enough information to
assess our market share in this market, as most of our competitors are privately
owned companies.
  41
  The home
textile and accompanying accessories market in Israel in which our "Vardinon"
stores compete is highly competitive. Vardinon's competitors in this market
include home textile departments in large retail chains, department stores and
privately owned stores.  In addition, there are also many companies
and distributors that market and sell home textile products to wholesale
customers.  We do not have any formal information about the size of
the home textile market and the market share of the various competitors in this
market, however, we estimate that our "Vardinon" chain is one of the leading
retailers in the premium home textile market.
 
 Our "Dr.
Baby" stores compete in the baby and young children accessories market, and our
"All for a Dollar" and "Kfar Hasha’ashuim" stores compete in the toys and
leisure accessories market and the back-to-school products market. We do not
have enough information to assess our market share in this market, as most of
our competitors are privately owned companies.
 
 Yield-Generating Real
Estate
 
 The yield-generating real estate market
in Israel is highly competitive and is characterized by a large number of
competitors.  The main factor affecting competition in this market is
geographic location of property.  There are properties in close
proximity to some of our properties that are similar in purpose and use, which
has the effect of increasing competition for the leasing of those properties as
well as reducing the rental rates for those properties.  Other factors
affecting competition are the leasing price, the physical condition of the
properties, the finishing of the properties and the level of the management
services provided to tenants.  Furthermore, the economic and financial
market crisis may further increase competition, leading to a reduction of rental
fees and a decline in demand for properties.  However, as most of our
yield-generating real estate is leased for our supermarkets, we believe that we
have limited exposure to the effects of the competition in this
market.
  Our
Operations
  Supermarkets
  Our
supermarket operations are conducted under the Mega Bool, Mega, Mega In Town,
Shefa Shuk and Eden Nature store formats, which are among the most
well-recognized retail names in Israel.
  Our
supermarkets offer a wide selection of supermarket goods.  The mix of
products of each supermarket format varies to address the preferences of its
target customers.  Many of our supermarkets offer specialty
departments such as full service bakeries, delicatessens, fresh meat and
prepared food departments; certain supermarkets also contain franchise
operations, which sell a variety of goods. In addition, we offer a range of
“Non-Food” and “Near-Food” items and operate several toy and houseware
departments within most of our large stores.  We also launched a
private label for the Company, called "Mega", that was expanded throughout our
"Mega Bool", "Mega in Town" and "Mega" store formats beginning on December
2008.  Following the reorganization of our retail activities, all of
our supermarket stores operations are owned by BSIP and its
subsidiaries.  As part of the reorganization of our real estate
activities, BSI transferred all of its supermarket store leases to BSIP, and
BSIP now leases the real estate underlying the stores that it operates from BSRE
and third parties.
  42
  The
following table provides certain information regarding our supermarket stores as
of December 31, 2008:
  Retail Format
                      
                      Number of Stores
                      
                      
                      Store Space (square
                        meters)Mega Bool (1)
                      
                      
                      36
                      
                      
                      
                      118,229Mega (2)
                      
                      
                      19
                      
                      
                      
                      69,768Mega in Town (3)
                      
                      
                      113
                      
                      
                      
                      122,784Shefa Shuk (4)
                      
                      
                      21
                      
                      
                      
                      36,473Eden Nature (5)
                      
                      
                      5
                      
                      
                      
                      7,277Total
                      
                      
                      194
                      
                      
                      
                      354,531
 
 (1) Hard
discount stores that designed to provide customers with name brand quality at
everyday affordable prices.
  (2) Large
stores (average size of approximately 4,100 square meters), primarily located
outside residential areas, offering a wide selection of food items and other
departments.
  (3)
Medium and small size stores primarily located in city centers and local
neighborhoods which combine discount prices with convenience for neighborhood
shoppers. This format is designed to bring discount shopping to the neighborhood
and city centers.
  (4)
Low-priced supermarkets with a selection of products designed to compete with
local competition and also oriented to ultra-orthodox Jewish
population.
  (5)
Supermarkets held 51% by BSI that specialize in organic, natural and health food
products.
 
 Non-Food
Retail
 
 Our 85%
subsidiary, Bee Group, holds and operates through subsidiaries large retail
chains with 247 stores, some of which are owned and operated by the subsidiaries
and some of which are owned and operated by franchisees as of May 31,
2009.  The stores are operated under the following brand names: (i)
"Naaman", which sells houseware products; (ii) "Vardinon", which sells home
textile products and accompanying accessories; (iii) "Sheshet", which sells
houseware and small electrical appliances; (iv) "Kfar Hasha’ashuim" (Toy
Village), which sells toys; (v) "Rav-Kat" and Dr. Baby, which sell baby and
young children accessories; and (vi) “All for a Dollar". The stores of our
"Naaman", "Vardinon" and "Dr. Baby" chains are primarily owned and operated by
us, while the stores of our "Kfar Hasha'ashuim", "Sheshet" and "All for a
Dollar" chains are primarily owned and operated by franchisees. In addition to
these stores, we have established toy and houseware departments within most of
our large stores, which are owned by us.
  43
  Each of
the subsidiaries of the Bee Group separately manages its own operations. The
relationship with the franchisees is generally governed by franchise agreements
between the relevant Bee Group subsidiary ("Franchiser") and the
franchisee.  The majority of the franchise agreements provide for a
term of 10 years with two renewal options, each for a period of five additional
years.  Under most of the agreements, the Franchiser and the
franchisee may terminate with prior written notice.
  The
franchisee generally commits to establishing its store(s) in designated
locations and purchasing products for the stores only from the Franchiser or
from third party suppliers designated by the Franchiser.  While the
Franchiser typically has no similar obligation to sell its products only through
its franchisees, in practice, aside from sales to the franchisees or through the
Franchiser's own stores, the Franchisers primarily sell their products only to
Blue Square and to the Alon Group.
  Bee Group
has one material franchisee that operates, both on its own and with other third
parties, seven "Kfar Hasha’ashuim" stores, two "All for a Dollar" stores, and
eight "Sheshet" stores.
  The
following table provides certain information regarding our non-food retail
stores as of December 31, 2008:
  Retail Format
                      
                      Number of
                        Franchised Stores
                      
                      
                      Number of Self
                        Operated Stores
                      
                      
                      TotalAll
      for a Dollar
                      
                      
                      35
                      
                      
                      
                      1
                      
                      
                      
                      36Kfar
      Hasha’ashuim
                      
                      
                      76
                      
                      
                      
                      1
                      
                      
                      
                      77Dr.
      Baby and Rav-Kat
                      
                      
                      4
                      
                      
                      
                      12
                      
                      
                      
                      16Sheshet
                      
                      
                      50
                      
                      
                      
                      —
                      
                      
                      
                      50Vardinon
                      
                      
                      —
                      
                      
                      
                      35
                      
                      
                      
                      35Naaman
                      
                      
                      5
                      
                      
                      
                      22
                      
                      
                      
                      27Total
                      
                      
                      170
                      
                      
                      
                      71
                      
                      
                      
                      241
  44
  Purchasing
and Distribution
  Supermarkets
  We
purchase products for our supermarkets through a central purchasing office that
selects products for all of our supermarkets and negotiates prices, promotions
and terms of payment with individual suppliers on a company-wide basis. We
believe that our large volume of purchases and our ability to offer chain-wide
exposure for our suppliers’ products and promotions, enable us to avail
ourselves of attractive volume-buying opportunities and manufacturers’
discounts.
  Through
our distribution center, we can distribute products from suppliers,
manufacturers and importers, thus reducing prices and broadening the range of
available products.  The distribution center is operated on a 40,000
square meter site.  At this site, we operate approximately 20,000
square meters as warehouse space.  We conduct the administration of
the warehouses and distribution by means of a computerized system that
consolidates orders from all the branches while giving consideration to
inventory levels, store requests and company planning.
  As of the
date of this Annual Report, we have obtained a building permit and are preparing
to begin building an additional distribution and logistics center which, as of
May 31, 2009, was held 100% by BSRE.  The distribution center would be
operated on a 16,000 square meter site and would be used for storage and
distribution of "Non-Food" and "Near-Food" products for our Non Food chains and
our supermarket stores.
  On April
5, 2009 BSIP entered into an agreement with
Yachin Agricultural Company Ltd. and Etz and Nir Ltd. (the "Lessors")
pursuant to which the Lessors will establish and operate a new planned
distribution and logistics center for fruits and vegetables on behalf of BSIP.
The Lessors jointly own an approximately 31.5 dunam property which has
building rights for 24,000 square meters and which is located in the area of
Hadarim junction. This new planned distribution center will include offices
and a warehouse. The Lessors undertook to obtain construction permits within six
months of the closing date (with an option to extend this period an
additional six months) and to transfer possession of the property within 45
months following the issuance of such permits. The period of the agreement is 12
years with two consecutive options of seven years and of five years and 11
months. The rent will be NIS 34 per square meter per month linked to the Israeli
CPI.
  We
purchase products for our supermarkets from approximately 900 suppliers,
including manufacturers, importers and distributors. In 2008, approximately 82%
of our grocery items and 96% of our meat and fish are delivered directly by
suppliers to some of our stores.  For certain other items, including
78% (in 2008) of fruits and vegetables, we provide distribution to our
supermarkets through our distribution center.  For the year ended
December 31, 2008, approximately 21% of our supermarket purchases were of
products distributed from the distribution center.
  45
  We
actively seek to diversify our suppliers.  However, we purchase most
of our dairy, fresh produce and poultry products from the Tnuva corporation,
which holds a leading position in the domestic dairy and poultry
markets.  In 2008 Tnuva’s products accounted for approximately 14% of
all the products sold at our supermarkets. In addition, the Strauss group, an
Israeli food manufacturer, accounted for approximately 9.4% of all products sold
at our supermarkets in 2008, and the Osem group accounted for approximately 6.9%
of all products sold at our supermarkets in 2008.  Because of our
status as a leading food retailer in Israel and the fact that we maintain an
excellent and long-standing relationship with Tnuva, Strauss group and Osem, we
do not believe that there is a material risk of future stoppage of supply of
products of these key suppliers.  However, we do not have a written
contract with Tnuva, Strauss group or Osem obligating them to supply products to
us.  In addition, in recent years, there has been a process of
consolidation among our suppliers.  As a result, our largest suppliers
now account for a larger percentage of our product purchasers.  The
ten largest suppliers for our supermarkets accounted for approximately 51.8% of
our product purchases in 2008. We have not experienced any material problems in
obtaining products of the quantity and type required.
  Non-Food
Retail
  Naaman,
Sheshet, "Kfar Hasha’ashuim" and "All for a Dollar" acquire the products and
accompanying accessories which they market from numerous suppliers in Israel and
abroad, mainly from the Far East. The overseas suppliers are generally
manufacturers.
  Vardinon
purchases its home textile products either as finished products or through
subcontractors, each of which is generally responsible for a certain part of the
manufacturing process. Vardinon has many suppliers and subcontractors in Israel
and abroad, mainly the Far East, India and Turkey, and they may vary from season
to season based on various factors.
  Vardinon
is dependent on one material supplier, Office Textile Ltd., which supplies
Vardinon with dyed fabric. Purchases from this supplier accounted for 39% and
33% of Vardinon's total purchases of materials and outsourced projects in 2007
and 2008, respectively.
  As of the
date of this Annual Report, we are planning a distribution and logistics center
for our non-food business.  See "Item 4. Information on the Company –
B. Business Overview – Purchasing and Distribution - Supermarkets.
  Marketing
  We
endeavor to create an awareness of our supermarkets as offering a combination of
broad selection, high-quality service and competitive prices.  Our
primary advertising outlets, in addition to point-of-sale marketing, are
television, newspapers, radio, internet, billboards and direct
mail.  Store promotions are conducted, from time to time, in all our
supermarkets, in specific chains or in individual stores.  These
promotions include our Loyalty Plan - "You", Mega club, Buy & Bonus
incentive program, price reductions, gifts, coupons or deferred payment
terms.
  46
  The goal
of our Loyalty Plan, which we established together with Dor Alon Energy In
Israel (1988) Ltd. and offers to our customers a Diners Club Israel credit card
bearing the name "You", or a planned new membership card, is to promote customer
loyalty to the Company and Dor Alon by, among other things, granting exclusive
benefits to the Loyalty Plan members, including establishing a cash-based reward
mechanism, and providing discounts and benefits at other businesses that would
join the Loyalty Plan. In addition, through the Loyalty Plan the Company may
provide other services such of personal finance, insurance products and tourisms
packages.  The benefits are advertised and disseminated each month via
mail to the members of the Loyalty Plan. During 2009, we intend to close our
“Buy & Bonus” and “Mega” frequent-buyer incentive programs and to offer the
members of such programs membership in our new planned "You" membership club,
which is designed to increase consumer traffic and encourage customers to
patronize our stores. These customer clubs grant a variety of discounts and
benefits to participants.
  Supermarkets
  We have
joint advertising and sales initiatives together with some of our
suppliers.  The stores accept cash, checks, credit cards, gift
certificates and prepaid electronic cards.
  During
the High Holiday and Passover seasons, we run gift certificates programs, under
which we issue and sell gift certificates and prepaid cards to institutions,
companies and individuals.  The gift certificates and the prepaid
cards can be used in our stores as well as other stores with which we entered
into collaboration agreements.  We also participate in tenders in
connection with the sale of our gift certificates and prepaid
cards.  From time to time, we also operate joint marketing promotions
with other entities.
  In
addition, we operate the Blue Center website which allows customers to place
orders via the Internet 24 hours a day and to have the products in our stores
delivered to our customers’ homes from a nearby store within a few hours.
Likewise, customers may order products by phone (through a calling center) or by
fax.  The service is provided (through 20 centers located at Mega
stores) in most of Israel.
  Non-Food Retail
  Our main
marketing channels for our non-food products are (i) the Bee Group stores
operating under Bee Group's various brand name retail chains, (ii) non-food
departments in our supermarkets and (iii) direct sales to wholesalers and
institutional customers.
 
 Our
Naaman chain markets its products to privately owned stores, retail chains,
institutional customers, employee committees and sales promotion
companies.  Our Vardinon chain markets its products through stores
that are owned and operated by Vardinon that are located primarily in shopping
centers, as well as to other customers, including, wholesalers, retail chains,
employee committees and catalogues.
  47
 
 As part
of a pilot program, Bee Group is establishing specialized departments for
household products in our supermarkets that will sell Naaman, Sheshet and
Vardinon products.
 
 Government
Regulation
  Supermarkets
  Our
operation of supermarkets in Israel requires permits from municipal authorities,
which are conditioned on the prior approval of various agencies, including the
health and environment ministries, the police and fire
departments.  If we are unable to obtain or maintain one or more
required permits, we may be required to close one or more stores or to take
other remedial action to obtain or maintain these permits. See “Item 3. Key
Information - D. Risk Factors - Failure to obtain or maintain permits required
for our operations may adversely affect our operating results”.
  Price
Control
  The
Israeli government is authorized to control the retail and wholesale prices of
goods and services offered in Israel.  At present, a few of the
products we offer in our stores, including bread, flour, eggs, milk and
margarine are subject to government-imposed price controls.  Any
imposition of more extensive price controls in the future than those that
currently exist may have a material adverse effect on our operating results. See
“Item 3. Key Information - Risk Factors - D. Government-imposed price controls
may have a material adverse effect on our operating results”.
  Deposits
for Drink Containers
  We are
required to charge a deposit for drink containers of less than 1.5 liters and
more than 0.1 liter and accept the return of empty containers for
refund.  The Knesset, the Israeli legislative body, considers from
time to time amendments to this law which, among other things would require
stores to also charge a deposit for drink containers of 1.5 liters and more and
accept the return of empty containers for refund.
  We have
incurred expenses to allocate storage space for the empty containers and
dedicate special cashiers for returning the deposits.  We have also
incurred expenses for additional personnel and equipment, including equipment in
some of our stores that enable consumers to automatically receive their deposits
while bringing back the empty containers without the need for store
personnel.
  Limits
on Expansion
  The
Israeli Antitrust Authority may limit our ability to execute our strategy of
expanding our market presence.  The Commissioner of the Israeli
Antitrust Authority may limit our ability to acquire existing stores or enter
into mergers to acquire existing stores.
  48
  Arrangements
between Major Supermarkets Chains and Large Suppliers
  From
April 2000 to May 2003, the Israeli Antitrust Authority conducted an
investigation into alleged restrictive trade arrangements between major
supermarkets chains in Israel and large suppliers. During the investigation, an
inquiry was conducted in our offices and our former CEO and other senior
officers were questioned.
  On
January 5, 2005, the Commissioner of the Israeli Antitrust Authority issued his
position regarding“commercial restrictive
practices between the dominant food suppliers and the major supermarket retail
chains”. According to the Commissioner’s position, some of these practices were
found to be restrictive trade agreements under the antitrust laws. The
Commissioner prohibited these practices unless approved by the Restrictive Trade
Practices Court or exempted by the Commissioner himself.
  Among the
practices that were found to be restrictive according to the Commissioner were
the following: arrangements with suppliers that determine the suppliers of the
retail chains, their identity and their number; arrangements for the management
of product categories in conjunction with suppliers; arrangements regarding the
retail selling price; arrangements for determining market share of a particular
supplier’s products and arrangements for determining prices made by suppliers to
competing chains; arrangements with regard of the use of suppliers’ manpower to
stock merchandise on the shelves of the chains’ stores.  Limits were
imposed on financial benefits to the chains with regard to display areas and on
special offers to chains for meeting certain sale targets.
  After the
publication of the position paper, the Commissioner stated his position that
these directives constitute a position paper, which is “intended to provide the
guidance concerning the normative status of various practices in the food retail
industry as perceived by the Antitrust Authority”. The Commissioner indicated
that this document does not have normative status.
  We have
been applying most of these directives among others, by an internal compliance
program that we have adopted.
  Presently
we do not know how, if at all, our business would be affected should the
Commissioner take any action against us with respect to those issues under
dispute which we believe are legal based on our consultations with our legal
counsel.
  In August
2006, the Restrictive Trade Practices Court approved a consent decree reached
between the Commissioner and certain food suppliers.  The consent
decree is directed at the food suppliers listed therein and stipulates various
prohibitions, conditions and restrictions that apply to these suppliers with
regard to certain practices. The consent decree addresses the following
arrangements:
  49
  ·
              Reduction in the number of
      suppliers.  Suppliers are prohibited from being a party
      to an arrangement by which they influence the setting of the number or
      identity of competing suppliers’ presence at retail chains. Decisions
      regarding the number and identity of suppliers and their products
      quantity, kind or location on the shelf space are to be made by the retail
      chain without interference by
suppliers.
  ·
              Acquisition of shelf and
      off-shelf display space. A dominant supplier is prohibited to be a
      part of: (i) an arrangement granting an allocation exceeding half of the
      overall display area designated for the product category in which he has
      dominance; (ii) an arrangement which its purpose or effect is granting
      exclusivity to one or more of the supplier’s products in an off-shelf
      display in which it has dominance (nevertheless, exclusive arrangement for
      off-shelf display for a limited discount period will not constitute a
      basis for enforcement measures under certain circumstances). In addition,
      arrangements with suppliers (as opposed to dominant suppliers) regarding
      allocation of shelf area or off-shelf display, if not prohibited according
      to the decree, may not exceed a period of one year (the retail chain and
      the supplier may enter a new arrangement at the end of the one year term,
      provided the period of such new arrangement does not exceed one year and
      is in accordance with the provisions of the
  decree).
  ·
              Category management:
      Unless prior approval of the antitrust authorities is obtained, a dominant
      supplier is prohibited to be party to an arrangement whose purpose or
      effect is the supplier involvement (including as advisor) in the process
      of category management (nevertheless, a retail chain may consult with a
      supplier regarding innovations in this
area).
  ·
              Shelve
      arrangements:  Whereas in his position document, the
      Commissioner determined that the use of suppliers’ representatives to
      physically arrange the shelves in the chains’ stores constitutes a
      restrictive arrangement, the suppliers disagree with this position, and
      the Commissioner agreed not to take enforcement measures with regard to
      such arrangements for 30 months, so long as such arrangements satisfy
      certain conditions. In February, 2009, the above period was extended by 36
      months, until February 2012.
  ·
              Discounts and rebates in
      exchange for meeting sales targets.  A dominant supplier
      may not be party to an agreement whose objective or effectis the grant of
      benefits to the retail chain in connection to meeting sales targets of the
      products in which the supplier has dominance, unless the benefit is given
      only as a discount to the purchase of units sold in excess of the
      supplier’s sales basis in the chain and is restricted to these units
      alone. The prices of units sold in excess of the sales goals shall not be
      lower than the production costs of these units. In addition, a dominant
      supplier is prohibited from sanctioning a retail chain for failure to meet
      monopolistic sales targets regarding products for which the supplier
      possesses monopolistic power.
  ·
              Setting market share. A
      supplier is prohibited from being a party to an arrangement whose purpose
      or effect is to determine the supplier’s market share (or restricting the
      market share of competing suppliers) in the chain’s
  sales.
  50
  ·
              Exclusivity in sales: A
      supplier is prohibited from entering into the following arrangements with
      retail chains without the prior approval of the antitrust authorities: (i)
      an arrangement whose purpose or effect is to restrict the ability of
      competing suppliers to respond to sales conducted by such supplier by way
      of lowering their prices and (ii) an arrangement whose purpose or effect
      is to restrict the ability of competing chains to respond to sales
      conducted by another chain, including by way of commitment of the supplier
      not to offer a similar sale to competing
chains.
  ·
              Price dictation by
      supplier. A supplier is prohibited from setting the consumer price
      of its products sold in the chain and from intervening in chain decisions
      regarding the setting of the consumer price of its products or of its
      competitors’ products.  Nevertheless, a supplier may recommend
      the resale consumer price of its products to the chain, provided that the
      supplier takes no action to enforce such
  recommendation.
  The
consent decree clarifies that nothing in the provisions contained therein
prevents the chain from allocating shelf space at its own independent
discretion, even if such allocation exceeds half the available shelf space, so
long as there is no involvement or interference from the supplier and so long as
there is no prior coordination or understanding with said supplier.
  The
Company is not a party to the consent decree; however, it could nevertheless
have an effect on the practices of the Company’s suppliers and indirectly on the
Company.
  Consumer
Protection Laws
  We are
obligated to label prices on our products on the basis of two main laws: The
Consumer Protection
Law, 1981, and the Commodities and Services (Control)
Law, 1957.  Contravention of these laws constitutes a criminal
offense.  In 2009, new regulations under the Consumer Protection Lawbecame effective under which we are obligated to indicate on the shelf
the price per measurement unit with respect to most of our products. Said
regulations impose on us additional costs and could increase the risk for
discrepancies between the prices that appear on the products, the prices that
appear on the shelf and the prices charged by the cash register. In 2007, we
were convicted in a plea bargain in connection with discrepancies between the
prices appearing on products, and the prices charged by the cash register at the
point of sale. As of the date of this Annual Report, two indictments were filed
against us and Hyper Hyper regarding the violation of the Consumer Protection Law. See
“Item 8. Financial information - A. Consolidated Statements and Other Financial
Information - Legal Proceedings”. These discrepancies are the result of human
error by personnel responsible for labeling our products and other circumstances
beyond the Company's control. We are making efforts to minimize these errors,
including directing store management to charge the lower price in situations
where a discrepancy is found between the price on a product and the price
appearing at the cash register.
  51
  We are
also obligated under these laws to advertise and conduct our business in a
manner that is not misleading to our customers.  Our obligations
include, among other things, ensuring that our advertised prices are the prices
that are actually charged by the cash registers in our stores, and ensuring that
our coupons may be used in our stores as advertised. In December 2005, the
applicability of the Consumer
Protection Lawwith respect to the prohibition of misleading conduct was
expanded to apply also to conduct following the completion of the transaction
between the consumer and the supplier.
  In
addition, under the Consumer
Protection Law, we are obligated to post our merchandise return policy in
our stores.  The law and regulations promulgated thereunder impose
various requirements regarding the location, details, size and shape of the
notice of such policy.
  In
addition, under theConsumer
Protection Law, a remedy of exemplary (punitive) damages may be provided
to plaintiffs for specific violations of the law under certain
circumstances.
  Regulations
under the Consumer Protection
Law also regulate the warranty and post-sale services of certain
electrical appliances. Under the regulations, sellers of new electrical
appliances (priced in excess of NIS 400) to the end user consumer are required
to assume the responsibilities of the manufacturer(s) of the appliances in the
event such manufacturer cannot be located.  Such responsibilities
include repairing any defect in the appliance (or, if necessary, exchange for
non-defective appliance) during the warranty period, which repairs must be made
within a certain period of time for certain appliances and, upon consumer
request, supply of spare parts during the warranty period (and for certain
appliances also one year thereafter). In addition, sellers must deliver to
consumers a manufacturer warranty certificate with the delivery of the
products.
  Recent
proposed amendments to the Consumer Protection Law, 1981
and to the regulations promulgated thereunder, would also grant to consumers
rights to cancel a transaction and receive a refund under various
circumstances.
  The Class Actions Law(the “Law”)
which codified prior existing class actions arrangements, including under the
Consumer Protection
Law  , among other things, the causes of action under which one
can bring a class action were substantially extended, the prerequisites for
certifying and maintaining a class action were alleviated and the eligibility
requirements for a class action representative were lowered. The Law is not
unique to the line of business in which we engage; however, the expansion of the
availability of the Law to potential claimants increases our exposure to
potential lawsuits.
  Several
proposed legislations have been submitted to the Knesset regarding the reduction
of usage of plastic (nylon) bags. Under the proposed legislations, it is
proposed, among other things, that: (i) business establishments (including food
retail chains) will not keep or use bags which are not bio-degradable; (ii) food
retail chains would be required to provide to its consumers with packing bags
designated for more than one use, free of charge or for minimal consideration;
(iii) a levy in the sum of NIS 1 would be imposed for each plastic bag (with
certain exceptions) to be collected from the consumers by the business
establishment and to be transferred to a cleaning protection fund; (iv) the
business establishment would offer to consumers the ability to purchase packing
bags for more than one use for not less than NIS 4.5 which are exempt from the
levy; and (v) various reporting obligations would be imposed on business
establishments to the supervisor of the Ministry of environment protection. This
proposed new legislation and other similar proposed legislation may increase our
operational expenses and may require us to make additional investments in our
stores if they were to become effective.
  52
 
 Proposed
Business License Regulation
  By virtue of The Businesses License Law, 1968,and the regulations promulgated thereunder, and as a condition of the
receipt of permits, we are required to comply with various safety, security,
health, environment and other requirements.  Under the proposed new
Businesses License Regulation
(Proper Sanitation Conditions to Grocery), some existing requirements
will be tightened and new requirements will be imposed on the operation of our
stores.  The new regulation would contain new or more stringent
requirements relating to the following: requirements as to the building of our
stores, designation of separated space to some specialty departments, drainage
system requirements, sanitation, ventilation, lighting, temperature, water,
sewage, waste handling, food storage, signage, food transportation and
maintenance requirements, cooling device requirements and display and quality
requirements.  This proposed new Business License Regulation,
would require us to make additional investments in our stores if it were to
become effective
 
 Gasoline
Stations
  We are
also subject to numerous laws and regulations relating to, among other things,
environment protection, licensing and permits proceedings, standardization
requirements and other requirements in connection with the construction,
establishment and operation of gasoline stations on our properties described
below in “Item 4.  Information on the Company - D. Property, Plants
and Equipment.”  As part of a pilot program to examine the feasibility
of establishing and operating gasoline stations on properties adjacent to our
stores, in 2006, we began operating our first gasoline station on one of our
properties. We have applied for a business license for the operation of this
gasoline station, but the business license has not yet been
granted.
  Non-Food
Retail
 
 Our
non-food retail business is subject to Israeli laws relating to imports,
customs, labeling of products and consumer protection laws, as well as to labor
laws and license and permit laws as they apply to the operation of our network
of stores.
 
 Our sales
activities are subject to general laws such as the Liability for Defective Products
Law, 1980, pursuant to which, under certain circumstances, we may be
liable for personal injuries resulting from defects in products that we
market.  We are also subject to the Consumer Protection Law,
1981, which is described above under " - Supermarkets". We are also
subject to the Supervision of
Products and Services Law, 1957, and orders promulgated pursuant to such
law.
  53
 
 Houseware
Products
 
 We are
subject to safety tests, quality control and certification by the Israeli
Standards Institution. These are primarily related to the release of metals from
ceramic appliances/wares, marking of wares/dishes, pressure cookers, lighters
and plasticware used for food and drink.
 
 Business
Permits
 
 Some of
our Bee Group stores do not have permits according to the requirements of the
Business Permits Law,
1968.  A lack of such permits by any store would be considered
a breach of the tenancy agreement for such store, which would allow the landlord
to annul the lease agreement. As of the date of this Annual Report, none of the
landlords has made use of this right.
  Related
Businesses
 
 Diners
Israel
  In
connection with the establishment of our joint Loyalty Plan with Dor Alon Energy
In Israel (1988) Ltd. (“Dor Alon”), in November, 2005, we and Dor Alon purchased
49% of the shares of capital stock of Diners Club Israel Ltd. (“Diners Israel”)
(36.75% to Blue Square and 12.25% to Dor Alon) from Credit Cards for Israel Ltd.
(“CAL”). Diners Israel, a credit card company in Israel and a licensee of Diners
Club International, is a subsidiary of CAL which itself is a subsidiary of
Israel Discount Bank Ltd.
  Under the
agreement with CAL, we and Dor Alon are entitled to share with CAL the net
income of Diners Israel in connection with the activities of the credit cards
bearing the "You" name based on our respective ownership interests in Diners
Israel.  The percentage of the net income of Diners Israel in
connection with credit cards activities outside the Loyalty Plan is to be
allocated to us and to Dor Alon in accordance with various ratios determined
based on the number of "activated" credit cards (as defined in the agreement)
issued to members of the Loyalty Plan from time to time, so long as certain
target numbers of such issued credit cards are met.  In addition, we
recently signed an agreement with CAL pursuant to which Loyalty Plan members are
to be issued Mastercard "You" credit cards that will be treated the same as the
Diners "You" credit cards for the purpose of our agreement with Dor
Alon.  See “Item 7.  Major Shareholders and Related Party
Transactions - B. Related Party Transactions” for more information on the
agreement with CAL and Diners Israel.
  54
  Mega Nofesh Yashir (Mega Direct
Vacation) In January, 2008, Blue Square entered into an agreement with
Issta Israel Ltd, ("Issta") a subsidiary of Issta Lines Ltd, Israel’s largest
travel agency, to acquire 50% of Issta’s operated "Nofesh Yashir" (direct
vacation) enterprise, operating travel services through an internet portal and a
travel services call center, for the consideration of US
$250,000.  Pursuant to the agreement, the parties established a
jointly owned (50% each) company that operates the travel and tourism joint
enterprise and develop it within Blue Square's supermarkets, through its
marketing and through the Nofesh Yashir Internet travel services portal and call
center.
  C.           Organizational
Structure
  Following
the reorganization of our supermarket retail activities, pursuant to which our
supermarket retail activities are centralized in our wholly-owned subsidiary,
BSIP, BSIP operates all of our supermarkets and seven supermarkets which are
owned by Eden Nature (our 51% subsidiary).  Following the
reorganization of our real estate activities, BSIP will lease the real estate
underlying the stores that it operates from BSRE and third parties.
  We
operate all of our "Non Food" outlets through our 85% owned subsidiary Bee
Group, which in turn holds approximately 66.85% of the outstanding shares of
Naaman Porcelain Ltd., which holds approximately 88.74% of the voting power and
71.15% of the share capital in Vardinon Textile Ltd., both of which are publicly
held and traded on the Tel Aviv Stock Exchange.  Below is a chart
indicating our holdings in our material non-food retail subsidiaries as of June
15, 2009:
  
  BSRE, Bee
Group and each of Bee Group's subsidiaries has its own board of
directors.  We appoint all or a majority of the board of directors of
each of these companies and typically our appointee serves as the chairman of
the board of directors of each company.  Although we appoint all or
most of the board of directors of each of BSRE, Bee Group and Bee Group's
subsidiaries, each company’s board of directors has independent fiduciary
obligations to all of its shareholders and to the company
itself.  Blue Square is obligated to deal with its partially owned
subsidiaries at “arm’s-length.”  Moreover, in the case of BSRE,
Vardinon and Naaman which are publicly traded on the Tel Aviv Stock Exchange,
the board of directors must include at least two external directors appointed
under Israeli law.  These external directors must satisfy all the
requirements of external directors under the Israeli Companies Law, 1999,
referred to as the Israeli Companies Law.
  55




Blue
Square owned 100% of the outstanding shares of BSIP as of June 15, 2009. BSIP,
in turn, through a wholly owned subsidiary, is the owner of our interests in a
number of its other subsidiaries and affiliates. Blue Square receives fees from
its subsidiaries, including BSIP and Hyper Hyper, as payment for the management
and consulting services it provides to them for purchasing, marketing, finance,
store development, budgets and control, accounting and financial reporting,
taxation, law, internal auditing and data processing services.




Blue
Square owned 78.45% of the outstanding shares of BSRE as of June 15,
2009.  The balance of BSRE’s outstanding shares are publicly held and
traded on the Tel Aviv Stock Exchange.  Blue Square receives fees from
BSRE as payment for the management services it provides to it for Chairman of
the board of directors services, financial and accounting management services
(including bookkeeping), computer management and maintenance service, legal
consulting and corporate secretary services, office space and related office
services, and internal audit services.




See “Item
7.  Major Shareholders and Related Party Transactions - B. Related
Party Transactions” for a description of the agreements relating to the fees
Blue Square receives from its subsidiaries.  For information
concerning the flow of funds between Blue Square and its direct and indirect
subsidiaries, see also “Item 5.  Operating and Financial Review and
Prospects - Liquidity and Capital Resources.”




Set forth
below is a list of our significant holdings as of June 15, 2009.  The
companies marked with an asterisk (*) are not consolidated in our financial
statements.




Company(1)
              
              Operations
              
              %
      Ownership
                  Held
      by Blue
                  SquareThe
      Blue Square Chain Investments & Properties Ltd.
              
              Supermarkets
              
              
              100
              %The
      Blue Square Chain (Hyper Hyper) Ltd.
              
              Supermarkets
              
              
              100
              %(2)Blue
      Square Real Estate Ltd.**
              
              Real
      estate
              
              
              78.45
              %(3)Bee
      Group Retail Ltd.
              
              Retail
      and wholesale of houseware and home textile, toys, leisure and baby and
      young children products
              
              
              85
              %(4)Diners
      Club Israel Ltd.*
              
              Credit
      cards
              
              
              36.75
              %(5)Eden
      Briut Teva  Market Ltd. (Eden Nature Market)
              
              Organic/Health
      Food Products
              
              
              51
              %(6)Mega
      Nofesh Yashir Ltd.
              
              Travel
      services
              
              
              50
              %Radio
      Non-Stop Ltd.*
              
              Local
      radio station
              
              
              33
              %
      (7)




(1)
            All
      companies are incorporated under Israeli
law.




56


(2)
            BSIP’s
      wholly owned subsidiary.




(3)
            The
      remaining shares of BSRE are held by the public and institutional
      investors and traded on the Tel Aviv Stock
  Exchange.




(4)
            We
      have the option to increase our holding in Bee Group Retail Ltd. to
      100%.  For a description of this option, please see see “Item
      10.  Additional Information – C. Material Contracts”. As of June
      15, 2009, Bee Group Retail Ltd., held approximately 66.85% of the
      outstanding shares of Naaman Porcelain Ltd., which held an approximately
      88.74% of the voting power and 71.15% of the share capital in Vardinon
      Textile Ltd., both of which are companies traded on the Tel Aviv Stock
      Exchange.




(5)
            The
      remaining shares of Diners Club Israel Ltd are held by Credit Cards for
      Israel Ltd. (51%), a subsidiary of Israel Discount Bank Ltd.,and by Dor Alon
      Energy In Israel (1988) Ltd. (12.25%) (through a subsidiary). As of the date of this
      Annual Report, the right of the Company to participate in the income of
      Diners Club Israel in connection with credit card activities outside the
      Loyalty Plan is subject to the satisfaction of various
      conditions.  See “Item 7.  Major Shareholders and
      Related Party Transactions - B. Related Party Transactions” for
      information with respect to our rights as a shareholder of Diners
      Israel.




(6)
            BSIP's
      51% subsidiary.




(7)
            Hyper
      Hyper holds its interest in this company through a wholly owned
      subsidiary, which holds a 33% equity interest in Radio Non-Stop
      Ltd.  The remaining interests are held by unaffiliated
      entities.In
      2007, Radio Non-Stop Ltd., won the tender for a renewal of the franchise
      for regional radio broadcasting for four years (which may be extended
      without a tender for additional three four-year
  periods).




**
              Including
      also a 50% interest in a 17,000 square meter shopping mall in Jerusalem
      owned by BSRE and a 50% interest in warehouses owned by BSRE covering
      approximately 22,000 square
meters.




D.              Property,
Plants and Equipment.




As of
December 31, 2008 we owned or leased (including through our subsidiaries)
approximately 469,400 square meters of space for our own use. In addition, we
owned or leased 61,000 square meters of yield generating real estate and 176,700
square meters of undeveloped property. The following table provides certain
details regarding the properties that we own and lease.


57




Properties
                                            
                                            Number
                                            
                                            
                                            Space (sq. meters)(1)Existing
      StoresOwned(including long term
      lease from Israel Land Administration)
                                            
                                            
                                            93
                                            
                                            
                                            
                                            164,800Leased
      under 5 years
                                            
                                            
                                            49
                                            
                                            
                                            
                                            24,600Leased
      between 6-10 years
                                            
                                            
                                            62
                                            
                                            
                                            
                                            53,700Leased
      over 10 years
                                            
                                            
                                            61
                                            
                                            
                                            
                                            125,900265
                                            
                                            
                                            
                                            369,000Stores
      in DevelopmentOwned
                                            
                                            
                                            1
                                            
                                            
                                            
                                            1,500Leased
      between 5-25 years
                                            
                                            
                                            15
                                            
                                            
                                            
                                            26,80016
                                            
                                            
                                            
                                            28,300Existing
      Offices and WarehousesOwned
      Office
                                            
                                            
                                            1
                                            
                                            
                                            
                                            9,400Leased
      Offices
                                            
                                            
                                            3
                                            
                                            
                                            
                                            1,500Owned
      Warehouses
                                            
                                            
                                            3
                                            
                                            
                                            
                                            26,000Leased
      Warehouses
                                            
                                            
                                            9
                                            
                                            
                                            
                                            35,20016
                                            
                                            
                                            
                                            72,100Total
      owned or leased for our own use
                                            
                                            
                                            297
                                            
                                            
                                            
                                            469,400Properties
      for InvestmentLeased
      to Third Parties (2)
      (3)
                                            
                                            
                                            22
                                            
                                            
                                            
                                            29,700Unutilized
      Properties
                                            
                                            
                                            12
                                            
                                            
                                            
                                            33,50034
                                            
                                            
                                            
                                            63,200Owned
      and leased undeveloped properties:Warehouses
      in development
                                            
                                            
                                            1
                                            
                                            
                                            
                                            74,000Undeveloped
      Land (1)
                                            
                                            
                                            20
                                            
                                            
                                            
                                            100,00021
                                            
                                            
                                            
                                            174,000




(1)
            The
      figures in this table do not include building
  rights.




(2)
            Including
      a 50% interest owned by BSRE in a 17,000 square meter shopping mall in
      Jerusalem, in which we operate a 5,000 square meter
  store.




(3)
              Including
      a 50% interest owned indirectly by BSIP in a 7,100 square meter shopping
      mall in Be’er Sheva.




In 2009,
we opened and plan to open approximately 14 additional supermarkets, totaling
approximately 17,000 square meters of store space, in localities whose
populations are currently under-served by supermarkets or in localities in which
we do not have sufficient market presence.In
2009,we
opened six supermarket stores and two Eden Nature stores, converted four Shefa
Shuk stores to Mega Bool stores, and closed one "Mega in Town" store. In
addition, we plan to continue to remodel some of our supermarkets to give them a
more “upscale” orientation, offering improved product selection and increased
focus on customer service.  Remodeling typically includes the
installation of new display fixtures, additional shelf space, specialty
departments and checkout counters. Our experience has been that supermarket
remodeling, which is conducted in each store every eight to twelve years,
usually improves sales per square meter.  We currently plan to spend
more than NIS 145 million (or $36.6 million at the exchange rate as of May
31, 2009), on the acquisition and development of new supermarkets and the
remodeling of our existing supermarkets through the end of
2009.


58


As part
of a pilot program to examine the feasibility of establishing and operating
gasoline stations on properties adjacent to our stores, in 2006, we began
operating our first gasoline station on one of our properties.  We
plan to examine the establishing and operating of additional gasoline stations
on our properties as part of this pilot program.  We purchase our
gasoline from the Dor Alon. See “Item 7. Major Shareholders and Related Party
Transactions - B. Related Party Transactions”.




Generally,
franchisees of our Bee Group chains lease their own store space directly.
However, there are a few franchisees that either sublease their stores from the
relevant Bee Group subsidiary, or lease their stores jointly with such
subsidiary.  All Bee Group stores that are operated directly by Bee
Group's subsidiaries and not by franchisees, lease their own store
space.




On April
1, 2008, Bee Group leased property for its operations and buildings in the
logistics center that will be built in Be'er Tuvia.  Bee Group
estimates that it will invest approximately NIS 10 million in shelving and
equipment in connection with this property.




For
further information regarding our real estate, including the transfer of the
Company's real estate to BSRE and the contemplated transfer of BSIP's real
estate to BSRE, please see “Item 4. Information on The Company - B. Business
Overview - Our Real Estate” and “Item 7.  Major Shareholders – B.
Related Party Transactions.”




ITEM
      4A.
            UNRESOLVED
      STAFF COMMENTS




Not
applicable.




ITEM
      5.
            OPERATING
      AND FINANCIAL REVIEW AND PROSPECTS




The
following discussion and analysis should be read together with “Item
3.  Key Information - A. Selected Financial Data” and our consolidated
financial statements and 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.”




In
accordance with the instructions of the Israeli Accounting Standard No. 29,
“Adoption of International Financial Reporting Standards (IFRS)”, which was
published in July 2006, we have adopted IFRS as issued by the IASB, with effect
from January 1, 2008, based upon the guidance in IFRS 1, "First-time adoption of
IFRS", and have prepared our financial statements according to IFRS. In
accordance with IFRS 1, we have presented comparative financial statements as of
and for the year ended December 31, 2007, prepared in accordance with IFRS. In
addition, we have disclosed in note 36 to our financial statements as of
December 31, 2008 included elsewhere in this annual report, the influence of the
transition to IFRS (from financial statements prepared in accordance with
Israeli GAAP) on our financial statements for the year ended December 31,
2007.


59


General




The year
2008 was principally characterized by the difficult macroeconomic environment
which impacted our markets and by our internal reorganization, which is part of
our strategy to enable us to address current competitive and marketplace
conditions in Israel.




Specifically,
the year 2008 was marked by a shift from economic growth in the first quarters
of the year to the beginning of a recession toward the end of the year. This
shift was accompanied by an increase in the prices of the products that we
purchase from most of our suppliers, an increase in the Israeli CPI and an
increase in energy prices.  In addition, toward the end of the first
quarter of 2008 our financial results were adversely affected by the threat of
an ultra orthodox boycott of our Shefa Shuk stores.




The
current global economic crisis and the resulting slowdown in the Israeli economy
has changed the markets in which we operate and affected the buying patterns of
our customers, as more customers are shifting their purchases to low-price and
hard discount stores, which have a lower profit margin.  The slowdown
has also affected the volume of purchases made by our customers in our local
neighborhood stores, reduced the sales at our Mega and Shefa Shuk stores and led
to a decrease in our market share in supermarket sales during 2008 compared to
previous years. As a result, in December 2008, we launched our "Mega Bool"
format, a hard discount store format. As of May 31, 2009, this initiative
included the conversion of 40 existing "Mega" and "Shefa-Shuk" stores of various
sizes to "Mega Bool" stores.




This
continues the trend of recent years during which we and our competitors have
established or expanded low-price and hard discount store formats. In August,
2007, we launched our “Mega In Town” format. The initiative included the
conversion of over 100 of our existing SuperCenter and Mega stores to the new
brand. "Mega In Town” is a discount supermarket brand designed to bring a
winning combination to customers: discount prices and convenience for
neighborhood shoppers. We continued our expansion of the "Mega In Town"
supermarkets in 2008.




In order
to increase the efficiency of our activities, during 2008 we began to implement
a comprehensive internal reorganization, by concentrating all of our retail
activities under BSIP, our wholly owned subsidiary since November 2008 (after
our successful tender offer for its remaining outstanding shares and its
delisting from the TASE),  concentrating our non-food activities under
the Bee Group, and beginning the process of bringing together all our real
estate activities under our subsidiary, BSRE (78.45% owned by us as of June 15,
2009), with Blue Square as a holding company. In addition, in September 2008 we
increased our holdings in Bee Group to 85% with an option to further increase
our holdings to 100% and concentrated all of our houseware activity under Bee
Group's subsidiary, Naaman, and we are working to capitalize on potential
operating synergies between our non-food activity and our retail
activity.


60


As
part of our strategy to improve our competitive position, in December 2008, we
also launched our new "Mega" line of private label goods that are sold in our
"Mega Bool", "Mega", and "Mega In Town" store formats. Private label products
provide customers with an attractive alternative selection of products that are
comparable in quality to name brand products.  We believe that our
private label products enhance customer loyalty, differentiate our stores from
those of our competitors and provide a competitive product to those offered by
our suppliers.  In addition, usually average gross profit from private
label products is higher than the average gross profit from other
products.




We
believe that the volume of annual sales in the organic food market in Israel has
been growing consistently and will continue to increase during the next few
years.  In order to benefit from this growth, in October 2007, we
acquired approximately 51% of the holdings of Eden Nature, which operates
organic/health food supermarkets, to take advantage of the growing local demand
for organic, natural and health food.  In the third quarter of 2008,
we doubled the size of our Eden Nature organic chain, with the goal of
establishing Blue Square as the clear leader of Israel's emerging organic/health
food sector.




We
currently operate our supermarket stores under five brands: Mega Bool, Mega In
Town, Mega, Shefa Shuk and Eden Nature. In planning the mix of our stores, we
have taken a regional view, with the goal of bringing our store brands within
the shopping range of every Israeli consumer. As expected, the conversion of our
neighborhood stores to a lower margin format has impacted our gross margins from
our supermarkets sales; however, we were compensated by an increase in sales
which resulted in an increase in total gross profit.




In 2008,
smaller supermarket chains continued to increase their market share and expanded
their presence in selected areas in Israel, often geographically beyond their
original locations, increasing competition in an already difficult
market.  The low barriers of entry, including the relatively low cost
of establishing a new smaller supermarket, has contributed to the increase in
number and expansion of smaller supermarket chains in recent
years.  In addition, in recent years smaller supermarket chains have
transitioned from competing only in the local neighborhood markets to joining
with other smaller supermarket chains and competing on a national scale with a
joint private label which competes with the private labels of the large
supermarket chains.  These smaller supermarket chains have also been
able to capture a significant part of the sales from the major chains in their
areas by using lower cost non-unionized labor and having lower operating costs
and, in some cases by operating on Saturdays and offering non-kosher food. Large
supermarket chains in Israel, including us, are kosher and therefore do not
offer non-kosher food or generally operate on Saturdays.  We and other
major chains have also responded to consumers’ focus on the price of products by
establishing or expanding low-price and hard discount store
formats.


61


We are
increasing the variety of products sold in our stores in three
categories:  “Fresh Food” items - such as bakery items, delicatessen,
pastry, fresh meat and vegetables offered in specialty departments, “Non-Food”
items - such as houseware, toys and infants products, entertainment and leisure
products, small electrical appliances, computers and computers accessories and
textile products, and “Near-Food” items - such as health and beauty aids,
toiletries, cleaning products, paper goods and baby supplies.  We are
also looking to provide a diversified range of financial products to our
customers to further increase the variety of products we offer to our
customers.  “Non-Food” and “Near-Food” items generate more revenues
per square meter than our food items and increase the portion of our customers’
shopping needs that are addressed in our supermarket stores.




In
addition, we have expanded our presence in “Non-Food” stand alone retail outlets
in an effort to establish Blue Square as a major player in the non-food retail
market.  In September 2008, we increased to 85% our holdings (with an
option to further increase our holdings to 100%) in Bee Group Retail Ltd.
(formerly known as “Hamachsan Hamerkazi Kfar Hasha’ashuim Ltd.”) ("Bee Group"),
a company that is a wholesaler and that operates (mostly through franchisees)
retail outlets, with activities in the houseware and home textile, toys, leisure
and baby and young children sectors.  In 2007 we acquired, through Bee
Group approximately 85.79% of the holdings of Vardinon Textile Ltd.
("Vardinon"), a company which imports, designs and distributes home textile
products and accompanying accessories. In 2007 we acquired, and in 2009 we
increased our holdings in Naaman Porcelain Ltd. ("Naaman"), one of Israel’s
major branded houseware retailers and wholesalers, which imports and markets
various houseware products, such as kitchen utensils, cutlery and dinner
sets.  Currently, through Bee Group, we hold approximately 66.85% of
the outstanding shares of Naaman, which holds approximately 88.74% of the voting
power and 71.15% of the share capital of Vardinon. We are working to capitalize
on potential operating synergies between Bee Group and the Company as a
whole.




Operating
Results




The
following table sets forth certain statement of income data as a percentage of
sales for the periods indicated:




Year
      Ended
                    December 31,2007
                
                
                2008%
                
                
                %Sales
                
                
                100.00
                
                
                
                100.00Gross
      profit
                
                
                26.5
                
                
                
                27.7Selling,
      general and administrative expenses
                
                
                22.4
                
                
                
                24.2Operating
      profit before other gain and losses and net gains from adjustment of
      investment property to fair value
                
                
                4.1
                
                
                
                3.6Operating
      profit
                
                
                4.3
                
                
                
                3.8Taxes
      on income
                
                
                1.0
                
                
                
                0.6Profit
      for the year
                
                
                2.5
                
                
                
                1.8


62


Year
Ended December 31, 2008 compared with year ended December 31, 2007




Sales.   Sales in
2008 were approximately NIS 7,429 million, or $1,954 million, an increase of
approximately 6.4% compared with sales of approximately NIS 6,982 million in
2007. The growth in sales derived primarily from:




·
            the
      opening of ten new supermarkets in 2007, which were open for the entire
      2008 and only a portion of 2007, and the opening of nine new supermarkets
      in 2008 (taking into account one supermarket that closed), including the
      accelerated expansion of the Eden Nature
format;




·
            an
      increase of 1.1% during 2008 in supermarket Same Store Sales1,
      reflecting the continued growth of the Mega In Town store format,
      partially offset by declining sales in the Shefa Shuk store format and
      Mega stores before their conversion to the Mega Bool store format;
      and




·
            an
      increase of NIS 132 million in connection with the ongoing expansion of
      stores of Bee Group Retail (“Bee Group”), and the consolidation in 2008 of
      the full-year results from Naaman Porcelain Ltd. ("Naaman") and Vardinon
      Textile Ltd. ("Vardinon"), compared with the previous year, in which the
      revenues of Naaman and Vardinon were only partially consolidated into the
      Company’s financial results.




Gross profit. Gross profit in
2008 was approximately NIS 2,060 million, or $541.8 million (27.7% of sales), an
increase of 11.2% compared with gross profit of approximately NIS 1,852 million
(26.5% of sales) in 2007.  The increase in our gross profit as a
percentage of sales  was the result of improved supplier terms; a
shift in the mix of sales between the Company’s store formats, and the expansion
of Bee Group, which is characterized by a higher sales gross margin compared to
the food sector.  The increase in our gross profit was partially the
result of a positive influence from increased prices.





1The percentage in same store sales is the percentage change in sales of
those stores that operated continuously during the entire reporting period of
both the current year and that preceding it. Stores are not deemed to have
operated continuously (and therefore not included as “same stores”) if such
stores were permanently closed during the reporting period or the preceding
period or were resized significantly during the period (including for renovation
or expansion purposes). Store resizing is considered significant if it exceeds
5% or more of the store’s original size.


63


Selling, general and administrative
expenses.  Selling, general and administrative expenses in 2008
were approximately NIS 1,795 million, or $472 million, an increase of 14.8%
compared with selling, general and administrative expenses of approximately NIS
1,563 million in 2007. This increase was mainly due to increased expenses
associated with the opening of new stores and the accelerated development of the
Eden Nature format; expenses associated with the launch of the Mega Bool store
format; a rise in the operating expenses of existing stores due to the increase
in energy and electricity prices; an increase in the Israeli CPI, which
increased CPI-linked expenses such as rent and municipal taxes; and the
increased expenses of the Bee Group associated with its expansion of the number
of its stores  and the  consolidation of the full-year
expenses of Naaman and Vardinon in 2008, compared with the consolidation of only
a portion of their expenses in the Company's 2007 results.




Operating profit
before other gains and losses and net gain from adjustment of investment
property to fair value.  Operating profit in 2008 before other
gain and losses and net gain from adjustment of investment property to fair
value was NIS 265 million ($69.8 million) (3.6% of sales) compared to NIS 289
million (4.1% of sales) in 2007. The decrease in operating income was primarily
due to the decrease in profitability of our food retail operations, mainly from
stores which were converted to the Mega Bool format, and the increased expenses
of Eden Nature due to the expansion of this store format during 2008. In our
non-food retail operations, operating profit decreased due to the operating loss
at Bee Group’s Dr. Baby store format resulting from the opening of eight
self-operating stores in 2008.





Net gain from adjustment of
investment property to fair value. In 2008, the Company’s recorded
income of NIS 19.1 million (U.S. $5.0 million) associated with the increase in
value of its investment property compared with NIS 10.5 million in 2007. This
increase in valuation mainly resulted from Hadar Talpiyot mall which is located
in Jerusalem, in which the company holds a 50% interest.





Other losses
(gains).  In 2008, the Company recorded other losses of NIS 2.5
million (U.S. $0.7 million) compared with other gains of NIS 3.1 million during
2007. These losses primarily resulted from a NIS 6.0 million (U.S. $1.6 million)
termination benefit expense associated with the Company’s efficiency program,
consisting mainly of the reduction of headcount at the Company’s headquarters,
and a provision of NIS 6 million (U.S. $1.6 million) associated with the
reduction of property value and depreciation. These losses were partially offset
by other gains in the amount of NIS 9 million (U.S. $2.4 million), which derived
from the decrease in the Bee Group‘s holdings in its subsidiaries, primarily
Sheshet, following Bee Group's reorganization which included the transfer of Bee
Group's holdings in Vardinon and Sheshet to Naaman.





Operating profit. Operating profit for 2008
was NIS 281.8 million (U.S. $74.1 million) (3.8% of sales) compared to NIS 302.7
million (4.3% of sales) in 2007, a decline of 6.9%.





Financial expenses,
net.  Financial expenses, net in 2008, increased by 84% to
approximately NIS 106 million, or $27.8 million, compared with financial
expenses of approximately NIS 57 million in 2007. This increase derived from the
increase in the consumer price index in 2008 compared to 2007, an increase in
net financial debt and hedging against a rise in the consumer price index,
partially offset by financial income of NIS 24 million in connection with the
revaluation of the Company's financial instruments.


64


Taxes on
income.  Taxes on income in 2008 were NIS 43.8 million, or
$11.5 million, compared with approximately NIS 69.8 million in 2007. As a
percentage of income before taxes on income, taxes on income decreased to
approximately 24.9% in 2008, compared with 28.4% in 2007.  The
decrease in the effective tax rate derived primarily from the decline in the
statutory tax rate from 29% in 2007 to 27% in 2008.





Profit for the year. Net income for 2008 was
NIS 132.4 million (U.S. $34.8 million) compared to NIS 175.8 million for 2007.
The portion of the net profit attributable to shareholders, was NIS 104.6
million (U.S. $27.5 million), or NIS 2.41 per ADS (U.S. $0.63), while the
portion attributable to the share of minority interests was NIS 27.8 million
(U.S. $7.3 million). The decrease in net profit derives from the decrease in
operating profit, and the increase in the financial expenses as explained
above.





Quarterly
Fluctuations





Our
business is subject to fluctuations in quarterly sales and
profits.  These fluctuations are primarily attributable to increased
sales and higher operating income in the holiday seasons occurring in different
quarters from year to year.  Thus, for example, in our supermarkets
and in our "Naaman", "Vardinon" and "Sheshet" chains increased sales
attributable to Passover, which occurs in either March or April, may be
realized in either the first or the second quarter, and sales attributable to
the Jewish New Year, which occurs in either September or October, may be
realized in either the third or the fourth quarter.  In our "Kfar
Hasha'ashuim" chain, increased sales are generally attributable to Purim, which
occurs in February or March, and to the "Back-to-School" season in
August.





Many of
our expenses are unrelated to the level of sales, and therefore a relatively
modest increase or decrease in sales, whether or not related to the timing of
holidays, tends to have a disproportionately large impact on our
profitability.




The
following table sets forth certain quarterly information.





Net
      sales
              
              
              Operating profit before other gains
      and
                  losses
      and net gain from adjustment of
                  investment
      property to fair valueNIS
              
              
              Percentage
                  of
                  Full
      Year
              
              
              NIS
              
              
              Percentage
                  of
                  Full
      Year(In
      thousands)
              
              
              
              
              
              (In
      thousands)2008
              
              
              7,429,121
              
              
              
              100.0
              %
              
              
              265,252
              
              
              
              100.0
              %First
      quarter
              
              
              1,821,158
              
              
              
              24.5
              %
              
              
              77,487
              
              
              
              29.2
              %Second
      quarter
              
              
              1,918,403
              
              
              
              25.8
              %
              
              
              83,335
              
              
              
              31.4
              %Third
      quarter
              
              
              1,936,236
              
              
              
              26.1
              %
              
              
              59,770
              
              
              
              22.6
              %Fourth
      quarter
              
              
              1,753,324
              
              
              
              23.6
              %
              
              
              44,460
              
              
              
              16.8
              %2007
              
              
              6,981,984
              
              
              
              100.0
              %
              
              
              289,198
              
              
              
              100.0
              %First
      quarter
              
              
              1,693,456
              
              
              
              24.3
              %
              
              
              79,266
              
              
              
              27.4
              %Second
      quarter
              
              
              1,680,859
              
              
              
              24.1
              %
              
              
              74,846
              
              
              
              25.9
              %Third
      quarter
              
              
              1,823,522
              
              
              
              26.1
              %
              
              
              69,063
              
              
              
              23.9
              %Fourth
      quarter
              
              
              1,784,147
              
              
              
              25.6
              %
              
              
              66,023
              
              
              
              22.8
              %


65




Exchange
Rates




At
December 31, 2008, the representative rate of exchange of the NIS to the dollar,
as published by the Bank of Israel, was NIS 3.802= $1.00. At May 31, 2009, the
representative rate of exchange of the NIS to the dollar, as published by the
Bank of Israel, was NIS 3.958 = $1.00.The table below sets
forth, for the periods and dates indicated, certain information concerning the
representative exchange rate of the NIS to the dollar, as published by the Bank
of Israel for the years ended December 31, 2004 through 2008:




Year
      Ended
                  December 31,
                
                Period End
                
                
                Average Rate(1)
                
                
                High
                
                
                Low(NIS
      per $1.00)2004
                
                
                4.31
                
                
                
                4.48
                
                
                
                4.63
                
                
                
                4.312005
                
                
                4.60
                
                
                
                4.49
                
                
                
                4.74
                
                
                
                4.302006
                
                
                4.30
                (2)
                
                
                4.46
                
                
                
                4.73
                
                
                
                4.182007
                
                
                3.85
                (2)
                
                
                4.11
                
                
                
                4.34
                
                
                
                3.832008
                
                
                3.80
                (2)
                
                
                3.59
                
                
                
                4.02
                
                
                
                3.23




(1)
            The
      average of the daily exchange rates in each
  year.


(2)
            During
      2006, 2007 and 2008, the US dollar depreciated in value vis-à-vis the NIS
      by 8.2%, 8.97% and 1.2%,
respectively.





The
following table sets forth certain information concerning the representative
exchange rate of the NIS to the dollar, as published for the months December
2008 through May 2009:




Month
                  
                  Period End
                  
                  
                  Average Rate(1)
                  
                  
                  High
                  
                  
                  Low(NIS
      per $1.00)December
                  
                  
                  3.80
                  
                  
                  
                  3.87
                  
                  
                  
                  3.99
                  
                  
                  
                  3.68January
                  
                  
                  4.07
                  
                  
                  
                  3.91
                  
                  
                  
                  4.07
                  
                  
                  
                  3.78February
                  
                  
                  4.16
                  
                  
                  
                  4.10
                  
                  
                  
                  4.19
                  
                  
                  
                  4.01March
                  
                  
                  4.19
                  
                  
                  
                  4.16
                  
                  
                  
                  4.25
                  
                  
                  
                  4.02April
                  
                  
                  4.16
                  
                  
                  
                  4.20
                  
                  
                  
                  4.26
                  
                  
                  
                  4.13May
                  
                  
                  3.96
                  
                  
                  
                  4.09
                  
                  
                  
                  4.17
                  
                  
                  
                  3.96


(1)
              The
      average of the daily exchange
rates.


Impact
of Inflation and Currency Fluctuations




Inflation
in Israel increases some of our expenses, which, because of competitive
pressures, are generally not offset, fully or as quickly, by increases in our
selling prices and revenues.  See “Item 3. Key Information - D. Risk
Factors - Impact of inflation may adversely affect our financial expenses and
operating income" and “- Currency fluctuations might affect our operating
results and translation of operating results."


66


Any
devaluation of the NIS against various non-Israeli currencies in which we or our
suppliers pay for imported goods has the effect of increasing the selling price
of those products which we sell in Israel in NIS and affecting our operating
results.  In particular, a devaluation of the NIS against the Chinese
currency could significantly increase the cost of production of our non-food
products at our Bee Group stores and the selling price of those products to our
customers.  An increase in price of imported goods by our suppliers
can usually be offset by an increase in the consumer price of such
goods.  This devaluation would have a greater affect on our non-food
retail business because a higher proportion of the goods that we sell in our Bee
Group stores is acquired from suppliers overseas.  This devaluation
would also cause an increase in our expenses as recorded in our NIS denominated
financial results even though the expenses denominated in non-Israeli currencies
will remain unchanged.




In
addition, because our financial results are denominated in NIS and are
translated into US dollars for the convenience of US investors, currency
fluctuations of the NIS against the US dollar may impact our US dollar
translated financial results.




Political
Conditions




We and
all of our subsidiaries are incorporated under Israeli law and our principal
offices and operations are located in the State of Israel.  Political,
economic, security and military conditions in Israel directly affect our
operations.  Since the establishment of the State of Israel in 1948, a
number of armed conflicts have taken place between Israel and its Arab
neighbors. A state of hostility, varying from time to time, in intensity and
degree, has led to security and economic problems for Israel.  Israel
signed a peace treaty with Egypt in 1979 and a peace treaty with Jordan in 1994.
Israel has not entered into any peace agreement with Syria and
Lebanon.  In the last few years, the establishment of a Hamas
government in Gaza has created additional unrest and uncertainty in the region
and has increased hostilities between Israel and the
Palestinians.   These hostilities have included terrorist acts in
Israel and military operations in the West Bank and Gaza.  These
hostilities had a negative effect on the Israeli economy.  In December
2008 Israel was engaged in an armed conflict with Hamas in the Gaza Strip, which
reduced the sales of some of our stores that are located in the southern region
of Israel.  In July 2006, a conflict with Hezbollah escalated
significantly on Israel’s northern border, as a result of which a number of our
stores located in the northern region did not operate according to their usual
schedule. We cannot predict the effect on our business if hostilities are
renewed or the security situation deteriorates in any part of the
country.




The
future of Israel’s relations with its Arab neighbors and the Palestinians is
uncertain and several countries, companies and organizations continue to
restrict business with Israel and with Israeli companies.  We believe
that in the past, these practices have not had a material adverse effect on
us.  However, we could be adversely affected by adverse developments
in Israel’s relationships with its Arab neighbors and the Palestinians, or by
restrictive laws, policies or practices directed towards Israel or Israeli
businesses.




Most of
Bee Group's imports during 2008 were from suppliers located in
China.  Because most of the products sold by the Bee Group are
manufactured overseas and imported from China, its activity may be affected by
changes in the political and economic conditions in China.


67


In
addition, because the Bee Group acquires most of its products from suppliers
outside of Israel, and most of its products are imported via the sea, a
prolonged general strike, shutdown or a disruption of any of the Israeli ports
for an extended period of time, including as a result of a military conflict,
would affect our ability to import such products or increase their prices. In
addition, since the peak selling season of some of our Bee Group stores is
during the holidays, disruptions in the ports during or adjacent to such holiday
seasons may adversely affect our sales and financial results.




Economic
Conditions




All of
our supermarket sales are made in Israel and we acquire a substantial majority
of the goods that we sell from Israeli suppliers.  Consequently, our
financial performance is dependent to a significant extent on the economy of
Israel. During 2007 and 2008, Israel's Gross Domestic Product rose by 5.3% and
4.1%, respectively. However, in recent quarters, the global economic crisis,
instability and uncertainty have affected the economic conditions in
Israel.  Initial reports indicate that the Israeli economy declined by
3.9% (annualized) at the first quarter of 2009. We believe that the economic
slowdown in Israel is affecting the buying patterns of our customers, as more
customers are shifting their purchases to low-price and hard discount stores,
which have a lower profit margin.  As a result, we have expanded our
low-price and hard discount store formats. We expect the economic slowdown in
Israel to adversely affect our financial performance, among other things, by
reducing our sales and our profitability.




The
global economic crisis has also affected our non-food retail business by causing
a slowdown in the growth of private consumption, which could affect the growth
of our houseware, home textile and baby and young children accessories
businesses.





In
addition, the global economic crisis has also reduced the availability
of   credit, increased the costs of financing and the terms under
which banks agree to provide financing.  These developments may reduce
the sales of our businesses, increase our costs of borrowing and reduce our
profitability. We are unable at this time to asses the extent, if any, of the
impact that the global economic crisis may have on our business..





In
addition, on May 13, 2009, Israel's cabinet approved the proposed state budgets
for the years 2009 and 2010, which include, among other things, a temporary
increase of 1% in the value added tax ("VAT") from 15.5% to 16.5% for an
18-month period, and an imposition of VAT, for the first time, on fruits and
vegetables.  The temporary increase in VAT to 16.5% is effective,
although the proposal to impose VAT on fruits and vegetables is subject to
change.  The Knesset (Israeli legislative body) is expected to vote on
the budget by mid-July.  The increase in VAT and the new imposition of
VAT on fruits and vegetables will increase the cost of the products that we sell
in our supermarkets and may affect our sales.


68


Trade
Agreements




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




In
addition, Israel, the EU (known as the European Union), and the European Free
Trade Association have a free trade agreement.  In recent years,
Israel has established commercial and trade relations with a number of other
nations, including China, India, Russia, Turkey and other nations in Eastern
Europe and Asia.




Corporate
Tax Rate




We are
subject to income tax in Israel at the rate of 26% of our taxable income in 2009
(27% in 2008).





The
income of the Company and its subsidiaries is taxed at the regular rate. In July
2004, an amendment (No. 140) to the Income Tax Ordinance was enacted. One
of the provisions of this amendment is that the corporate tax rate is to be
gradually reduced from 36% in 2003, to 30% in 2004.  In August 2005, a
further amendment (No. 147) was published, which makes a further revision
to the corporate tax rates prescribed by Amendment No. 140. As a result of
the aforementioned amendments, the corporate tax rates for 2004 and thereafter
are as follows: 2004 - 35%, 2005 - 34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009
- 26% and for 2010 and thereafter - 25%.




Under the
Inflationary Adjustments Law, carry forward losses were linked to the CPI. In
February 2008, the Knesset (Israeli legislative body) passed a law according to
which the provisions of Inflationary Adjustments Law will no longer apply to the
Company in 2008 and thereafter.




For
further tax information, see “Item 10.  Additional Information - E.
Taxation -Israeli Tax Considerations.”




Critical
Accounting Policies and Estimates




We have
chosen accounting policies that we believe are appropriate to report accurately
and fairly our operating results and financial position, and we apply those
accounting policies in a consistent manner.  Our significant accounting
policies are summarized in Note 2 to the Consolidated Financial
Statements.




We base
our estimates on historical experience, where applicable, and on other
assumptions that we believe are reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions, and
could have a material impact on our reported results.


69




We
believe that the following accounting policies are the most critical in the
preparation of our financial statements because they involve the most difficult,
subjective or complex judgments about the effect of matters that are inherently
uncertain




Impairment
of non financial assets




We review
at each balance sheet date whether any events have occurred or changes in
circumstances have taken place which might indicate that there has been an
impairment of property, plant and equipment and identifiable intangibles. When
such indicators of impairment are present, we evaluate whether the carrying
value of the asset in our accounts can be recovered from the cash flows
anticipated from that asset, and, if necessary, records an impairment provision
necessary to adjust the carrying amount to the recoverable amount.




When it
is not possible to assess whether an impairment provision is required for an
individual asset which does not generate independent cash flows, the need for
such a provision is assessed in relation to the recoverable value of the
cash-generating unit to which that asset belongs.  For a
cash-generating unit to which goodwill has been allocated, any impairment loss
relating to that unit initially reduces the goodwill and the balance reduces the
carrying amount of the other assets.




In 2007,
we evaluated impairment separately for each store as a cash-generating unit. In
2008, we reorganized the food retail activities to incorporate all activities
under one subsidiary while, at the same time, organized the brand names in order
that we could meet the needs of specific customers in each geographic area
(promotions, prices and variety) and increase customer loyalty program
activities. As such, in 2008, we evaluated impairment separately for each store
or the cash-generating unit to which the store belongs when the cash inflows of
one store are dependent on the cash inflows of another store in the same
geographic area. In evaluating impairment, we consider corporate assets relating
to the stores or other cash-generating units as well as indirect costs that are
directly attributable, or that can be reasonably and consistently allocated, to
the stores or cash generating units.




The
recoverable amount of an asset is the higher of the net selling price of the
asset's fair value less cost to sell and its value in use. These calculations
require the use of estimates. In calculating the impairment for the reported
years, based on discounted expected future cash flows, we used a discount rate
before tax for each cash-generating unit (CGU). For discount rates used by the
Company, see note 8C to the Consolidated Financial Statements.




In 2008,
we recorded impairment provisions resulting in net amount of NIS 3.4 million. In
2007, we recorded a reversal of impairment provisions resulting in the net
amount of NIS 13.5 million. Impairment provisions or the reversal of such
provisions are included in the income statement within Other gain or
losses.




Application
of alternative assumptions and definitions, such as reviewing long-lived assets
for impairment at a different organizational level, could produce significantly
different results


70


Goodwill




Goodwill
is tested annually for impairment and when circumstances indicate that the
carrying value may be impaired, goodwill is carried at cost less any accumulated
impairment losses.  Impairment losses on goodwill are not
reversed.




Goodwill
is allocated to cash-generating units or groups of cash-generating units that
are expected to benefits from the business combination in which the goodwill
arose.




Goodwill
is allocated to three identified groups of cash-generating units.




The
recoverable amount of a CGU is determined based on value-in-use calculations.
These calculations use pre-tax cash flow projections based on financial budgets
approved by management and management estimation covering a five-year period.
Cash flows beyond the five-year period are extrapolated using the estimated
growth rates stated below. The growth rate does not exceed the long-term average
growth rate for the business in which the CGU operates.




Results
of the goodwill impairment for each cash-generating unit (CGU) review performed
during 2008 are summarized in Note 8C to the Consolidated Financial
Statements.




The key
assumptions used for value in-use calculations are as follows: expected gross
margin, weighted average growth rate used to extrapolate cash flows beyond the
budget management estimations covering a five-year period, and pre-tax discount
rate applied to cash flow projections.




The
annual impairment review requires the extensive use of accounting judgments and
financial estimates.  Application of alternative assumptions and
definitions, such as reviewing goodwill for impairment at a different
organizational level, could produce significantly different results. 
Similar to our policy on impairment of long-lived assets, the cash flow
projections embedded in our goodwill impairment reviews can be affected by
several items, such as inflation, business valuations in the market, the economy
and market competition.




Revaluation
of investment property




Investment
property is presented at fair value. In certain cases, fair value is determined
using discounted cash flows that are based on assumptions as to discount rate.
Changes in the discount rate will change the calculated fair value and may
therefore materially affect the results of our operations. The range of discount
rates used is 8%-12% per annum (mainly 8-8.75%).




Retirement
benefit obligations and Provision for unutilized sick leave




1)           Retirement
benefit obligations




Labor
laws and agreements, and the practice, require us to pay retirement benefits to
employees dismissed or retiring in certain other circumstances.


71


We
operate various pension schemes.  The schemes are generally funded
through payments to insurance companies or trustee-administered funds,
determined by periodic actuarial calculations. We have both defined benefit and
defined contribution plans.




Our
obligation to pay retirement benefits is generally treated as a defined benefit
plan. However, for employees for whom the retirement benefit obligation is
covered by section 14 of the Israel Severance Pay Law, the obligation is treated
as a defined contribution plan.




Defined
Benefit Plan




The
retirement benefit obligation recognized in the balance sheet is the present
value of the defined benefit obligation at the balance sheet date less the fair
value of plan assets. The defined benefit obligation is calculated annually
using the projected unit credit method.




The
present value of the defined benefit obligation is determined by discounting the
estimated future cash outflows (after taking into account the expected rate of
salary increases and other actuarial assumptions) by reference to Israeli
Government bonds that are denominated in the currency in which the benefits will
be paid and that have terms to maturity approximating the terms of the related
pension liability.




We
determine the appropriate discount rate at the end of each year.  This
is the interest rate that should be used to determine the present value of
estimated future cash outflows expected to be required to settle the retirement
obligations. In determining the appropriate discount rate, we consider the
interest rates of Israeli government bonds that are denominated in the currency
in which the benefits will be paid and that have terms to maturity that are
comparable to the terms of the related retirement liability.




The
present value of the obligations depends on a number of factors that are
determined on an actuarial basis using a number of assumptions. The assumptions
used in determining the net cost of retirement benefits include the discount
rate. Other key assumptions, such as future wage increases and retirement rates,
are based in part on current market conditions and on past experience. Any
changes in these assumptions will impact the carrying amount of the obligations.
Actuarial gains and losses are recognized outside of profit and loss in the
"statement of recognized income and expense" in the period in which they
arise.




Defined
Contribution Plan




A defined
contribution plan is a pension plan under which we pay fixed contributions into
a separate entity.  Our obligation to the employees for whom the
retirement benefit obligation is covered by section 14 of the Israel Severance
Pay Lawas
part of the defined contribution plan is to make regular contributions to a
separate and independent entity, and we have no legal or constructive
obligations to pay further contributions if the fund does not have sufficient
assets to pay all employees the benefits relating to employee service in the
current and prior periods.


72


2)           Provision
for unutilized sick leave




Pursuant
to employment agreements, certain employees are entitled to receive payment for
a certain number of sick leave days per year which accumulate to future periods.
Under these said agreements, the Company has undertaken to pay each employee,
upon retirement, certain amounts which depend on the balance of the unutilized
days and on the cumulative number of sick leave days the employee has utilized
during his employment with the Company.




The
provision for unutilized sick leave is based on an annual actuarial calculation:
in making such a computation, the actuary makes actuarial assumptions (such as
the rates of employee turnover, future salary levels). The cost of this benefit
is recognized using the same method used for defined benefit retirement plans.
Actuarial gains and losses are recognized outside of profit or loss in the
Statement of Recognized Income and Expense the period in which they arise. Any
changes in these assumptions will impact the carrying amount of the
obligations.




For key
management assumption used in the annual actuarial calculation for retirement
benefit obligations and provision for unutilized sick leave, see note 22 to the
Consolidated Financial Statements.




Provisions
for claims




The
provisions for legal claims are recorded based on the estimates of our
management (after consulting with the legal counsel) as to the likelihood that
cash flows will be required to settle these liabilities and as to the amount of
such cash flows.




Income
taxes and deferred taxes




There are
many transactions and calculations for which the ultimate tax determination is
uncertain. We recognize liabilities for anticipated tax issues based on
estimates as to whether additional taxes will be due. Where the final outcome of
these matters differs from the amounts that were initially recorded, such
differences will impact the current and deferred income tax assets and
liabilities in the period in which such determination is made.




In
addition, we recognize deferred tax assets and tax liabilities based on the
difference between the carrying value of such assets and liabilities and their
amount for tax purposes. We continually assess the recoverability of deferred
tax assets based on historical taxable income, expected taxable income, the
expected timing of the reversals of temporary differences and the application of
tax planning strategies. If we is unable to generate sufficient future taxable
income or actual results differ from its other assumptions, we might be required
to reduce our deferred tax assets or to increase our deferred tax liabilities,
which will increase our effective tax rate, and negatively affect our
operations.


73


Impairment
of available-for-sale financial assets:




We follow
the guidance in IAS 39 to determine when an available-for-sale financial asset
is impaired.  This determination requires significant
judgment.  In making this judgment, we evaluate, among other factors,
the duration and extent to which the fair value of an investment is less than
its cost as well as the financial position of and short-term business outlook of
the issuer of the instrument, including factors such as industry and sector
performance, changes in technology and operating and financing cash
flows.




Fair
value of derivative and other financial instruments




The fair
value of financial instruments that are not traded in an active market (for
example, derivatives) is determined by using valuation techniques. We use our
judgment to select a variety of methods and make assumptions that are mainly
based on market conditions existing at each balance sheet date. We have used
discounted cash flow analysis for various derivative financial assets that are
not traded in active markets. Changes in assumptions could affect the reported
fair value of these financial instruments.




Recently
issued accounting pronouncements




For
information on recently issued accounting pronouncements, see note 2bb to our
consolidated financial statements.




Liquidity
and Capital Resources




Sources
and Uses of Cash




Sources.




Our
principal source of liquidity is the cash generated by our
operations.  Both Blue Square and its significant subsidiaries have
generally generated sufficient cash from their operations to satisfy their
respective operating requirements.  The available cash resources of
BSIP, BSRE, Bee Group and their subsidiaries have historically been used, and
are expected to continue to be used, to finance the expansion of these
companies.




Cash
generated by operations was approximately NIS 410 million in 2008, an increase
of 18% compared with approximately NIS 348 million in 2007. This increase in
cash generated by operations in 2008 was mainly due to the growth in sales in
2008 and the increase in cash flow from operating activities derived principally
from the change from positive working capital in 2007 to negative working
capital in 2008.




In 2008,
approximately 34% of our supermarket sales were paid for with cash, checks and
gift certificates issued by the Company at the point-of-sale, approximately 63%
of supermarket sales were paid for with credit cards and approximately 3.0% of
supermarket sales were paid for with other short-term credit
arrangements.


74


During
2008, the average time period that we held inventory was 32.4 days and the
average time period within which our accounts receivable were paid was 32.1
days.  By contrast, as of such date the average time period for
payment of our accounts payable was 58.7 days.  Accordingly, increased
capital resources are not required to support an increase in our receivables or
inventories because we generally sell our products before we pay our
suppliers.




Other
sources of liquidity are long-term and short-term borrowing from
banks.  During 2008, we received from banks and other financial
institutions long-term borrowings of NIS 231 million, or $60.9 million and
short-term borrowings, net, of NIS 16 million, or $4.1 million, and during 2008,
we repaid long-term borrowings in the amount of NIS 131 million, or $34.3
million and interest in the amount of NIS 89 million, or $23.5
million.




In August
2006, BSRE completed its initial public offering of ordinary shares, unsecured
convertible (Series A) and non-convertible (Series B) debentures on the Tel Aviv
Stock Exchange.  BSRE received net proceeds of approximately NIS 147.6
million in consideration for its ordinary shares and net proceeds of
approximately NIS 731.2 million in consideration for the
debentures.  The proceeds from the issuance of the debentures were
used, among other things, to repay long-term borrowings of NIS 518 million, or
$122.6 million, that the Company transferred to BSRE at the time of the transfer
of the real estate assets to BSRE while the Company retained the proceeds of the
loan.  These long-term loans were incurred by the Company as part of
its preparations for the transfer of real estate assets and related financial
obligations to BSRE prior to its initial public offering.




In
September 2008, BSRE completed the issuance of an additional NIS 125 million in
principal amount of unsecured non-convertible (Series B)
debentures.  BSRE received net proceeds of approximately NIS 121.3
million or $31.9 million in consideration for the debentures.  The
proceeds from the issuance of the debentures were used, among other things, for
investments in real estate and for working capital.  The terms of
these debentures are identical to the terms of the non-convertible (Series B)
debentures issued by BSRE in August 2006.




On May
20, 2009, the Israel Securities Authority approved the publication of a shelf
prospectus that was filed by BSRE. The shelf prospectus is valid for a period of
two years, and it may be used by BSRE to raise capital in the future through the
issuance of shares, debentures, and/or options at the election of BSRE. The
shelf prospectus does not contemplate an immediate public offering.





As
of December 31, 2008, the remaining principal balance (linked to the Israeli
CPI) of BSRE's convertible (Series A) and non-convertible (Series B) debentures
was NIS 924 million.


75





In 2003,
we issued NIS 200 million in aggregate principal amount of unsecured 5.9%
convertible and NIS 200 million in aggregate principal amount of nonconvertible
debentures.  The installments of principal on the convertible
debentures are due in 2007, 2009 and 2011, and the installments of principal on
the nonconvertible debentures are due in 2012, 2013 and 2014. During 2008, we
did not repay any convertible debentures and none were converted into
shares.  As of December 31, 2008, the remaining principal balance
(linked to the Israeli CPI) of the NIS 200 million convertible debentures was
approximately NIS 37 million.




Uses.




During
2008, we repaid long-term borrowings in the amount of NIS 131 million, or $34.3
million, and interest in the amount of NIS 89 million, or $23.5 million, and we
paid dividends to minority shareholders of subsidiaries in the amount of NIS 22
million or $5.8 million. We also paid a dividend to our shareholders in the
aggregate amount of NIS 150 million, or $39.4 million.




In recent
years, we funded our renovation, remodeling and expansion programs primarily
from cash generated by our operations and from long and short-term loans from
banks. During 2008, we invested approximately NIS 282 million, or $74.2
million, in fixed assets and investment property, a 17% increase from our 2007
investment of NIS 241 million. Of our fixed asset investment and investment
property in 2008, we invested NIS 89.5 million, or $23.7 million, in land
and buildings, including land that we leased, as compared with NIS 82.7
million in 2007. We currently plan to spend in excess of NIS 145 million, or
$36.6 million for the development or acquisition of new supermarkets, the
renovation and remodeling of our existing supermarkets and related investments
through the end of 2009.  We intend to finance our store development,
renovation, modeling, expansion and acquisitions mainly from cash generated by
our operations and from borrowings from banks and others.




In
November 2008, pursuant to a cash tender offer, we completed the acquisition of
the BSIP shares that were not previously held by us, for the aggregate
consideration of NIS150.7 million, or $40.2 million (at that time). We currently
own 100% of the shares of BSIP, and BSIP's shares are no longer traded on the
Tel-Aviv Stock Exchange.




In
September 2008, we acquired an additional 25% of the shares of Bee Group for the
aggregate consideration of NIS 35.4 million, or $9.8 million (at that time),
increasing our holdings in Bee Group to 85%.




In
October, 2007, we purchased (through Bee Group) 57.87% of the holdings of Naaman
Porcelain (51.5% on a fully diluted basis) in consideration for approximately
NIS 101 million or approximately $26.26 million (at that time). In March and May
2009, we purchased (through Bee Group) additional shares of Naaman, in
consideration for approximately NIS 7 million, or approximately $1.8 million,
following which Bee Group's holdings in Naaman were
approximately  66.85% of the outstanding shares.




InOctober, 2007, we
purchased 51% of the holding of Eden Briut Teva Market Ltd. ("Eden Nature") in
consideration for approximately NIS 22.5 million or approximately $5.85 million
(at that time). In addition, under the agreement, (i) we provided Eden Nature
with shareholder loans in the amount of NIS 47 million and (ii) we will provide
all guarantees and financing required in connection with Eden Nature’s
operations in the future, the repayment of existing shareholder loans in the
amount of NIS 4.7 million which has since been repaid, and the payment of a
bonus to Eden Nature’s CEO upon the satisfaction of various thresholds which
have not yet been satisfied.


76


In April,
2007, we purchased (through Bee Group) 85.79% of the holdings of Vardinon
Textile Ltd. in consideration for approximately NIS 38 million or approximately
$9.88 million (at that time).




Dividends




The
following table sets forth dividends paid by the Company from January 1, 2007
until the date of this Annual Report:




Date
      of payment
                                  
                                  Amount
      per share
                                  
                                  Total
      amount(1)October
      7, 2008
                                  
                                  NIS
      3.46 ($0.99)
                                  
                                  NIS
      150 million (approximately $42.82 million)October
      8, 2007
                                  
                                  NIS
      5.07 ($1.27)
                                  
                                  NIS
      220 million (approximately $55 million)April
      19, 2007
                                  
                                  NIS
      1.45 ($0.35)
                                  
                                  NIS
      60 million (approximately $14.7
million)




(1)
      In accordance with the representative rate of exchange of the NIS to the
      dollar as of the date of the payment of the
  dividend.




In
addition to the dividends described above, the following dividends were paid by
the Company from 2002 to 2006:




Year
      of payment
                              
                              Amount
      per share
                              
                              Total
      amount(1)2006
                              
                              NIS
      2.81 ($0.62)
                              
                              NIS
      110 million (approximately $24.4 million)2005
                              
                              NIS  2.29
      ($0.51)
                              
                              NIS
      89 million (approximately $20 million)2004
                              
                              NIS
      6.6 ($1.48)
                              
                              NIS
      253 million (approximately $56.7 million)2003
                              
                              NIS
      7.71 ($1.72)
                              
                              NIS
      295 million (approximately $66.1 million)2002
                              
                              NIS
      3.35 ($0.72)
                              
                              NIS
      128 million (approximately $27.3
million)




(1)
                  In
      accordance with the representative rate of exchange of the NIS to the
      dollar as of the date of the payment of the
  dividend.




Blue
Square’s board of directors has resolved that we will not distribute dividends
in any quarter if the ratio of our net financial obligations (as defined by
S&P-Maalot, an Israeli rating agency) to EBITDA for any quarter exceeds 3.5
until June 30, 2006 or exceeds 3.0 thereafter.  Blue Square’s board of
directors also resolved that Blue Square would not distribute dividends in any
quarter if the ratio of the unencumbered fixed assets (following depreciation)
and investment property as set forth on our financial statements to financial
obligations (as defined by S&P-Maalot) for a quarter is below 120%.
According to our unaudited financial reports, as of March 31, 2009, the ratio of
the Company's financial obligations to EBITDA was 3.6, and the ratio of its
unencumbered fixed assets to the financial obligations was
160%.  Thus, the Company is currently limited in its ability to
distribute dividends until the ratio of the Company's financial obligations to
EBITDA returns to 3.0 or below.


77


Dividends
paid by BSIP from 2004 until the date of this Annual Report:




Date
      of payment
                              
                              Amount
      per share
                              
                              Total
      amount(1),
      (2)October
      8, 2007
                              
                              NIS
      6.1 ($1.52)
                              
                              NIS
      200 million (approximately $50 million)April
      12, 2007
                              
                              NIS
      0.76 ($0.19)
                              
                              NIS
      25 million (approximately $5.9 million)April
      11, 2005
                              
                              NIS
      2.44 ($0.56)
                              
                              NIS
      80 million (approximately $18.6 million)(3)May
      30, 2004
                              
                              NIS
      12.21 ($2.68)
                              
                              NIS
      400 million (approximately $87.8
million)




(1)
                In
      accordance with the representative rate of exchange of the NIS to the
      dollar as of the date of the payment of the
  dividend.




(2)
                Blue
      Square's share in the distribution of the dividends was approximately
      80%.




(3)
                The
      dividend distribution required a court approval (which was granted on
      March 6, 2005) because the distribution
      did not meet the “profit test” under the Israeli Companies
      Law.  The distribution was made from
      capital gains that were originally classified as a capital reserve that
      originated from a transaction in 1998 with a former controlling
      shareholder. Due to this transaction, the Company reclassified its share
      in this capital gain in the amount of NIS 44.9 million from a capital
      reserve (within additional paid in capital) to retained
      earnings.




Dividends paid by BSRE until the
date of this Annual Report:




In August
2006, the board of directors of BSRE adopted a policy that BSRE will distribute
dividends in each of years 2006 to 2008 in the amount of no less than 25% of the
net profits of BSRE in such year. In November 2008, BSRE's board of directors
approved a decision to extend this policy for the years 2009 and
2010.  Such distributions are subject to the “profit test” under the
Israeli Companies Law at the relevant dates and to other decisions of BSRE board
of directors, including decisions designating a different use of BSRE's profits
and/or a change in the BSRE dividend policy.




Date
      of payment
                              
                              Amount
      per share
                              
                              Total
      amount(1)
      (2)April
      20, 2009
                              
                              NIS
      1.35 ($0.32)
                              
                              NIS
      16.8 million (approximately $4.0 million)April
      28, 2008
                              
                              NIS
      1.58 ($0.46)
                              
                              NIS
      19.7 million (approximately $5.7 million)April
      12, 2007
                              
                              NIS
      0.78 ($0.19)
                              
                              NIS
      9.7 million (approximately $2.3
million)




(1)
                In
      accordance with the representative rate of exchange of the NIS to the
      dollar as of the date of the payment
      of the dividend.




(2)
                Blue
      Square's share in the distribution of the dividends was approximately
      80%.




Short-Term
Credit from Banks




The following table sets forth the
principal terms of our short-term credit frombanks and
others:


78




December 312007
                        
                        
                        2008NIS in thousandsShort-
      term credit from banks
                        
                        
                        53,749
                        
                        
                        
                        77,988Current
      maturities of Long-term loans
                        
                        
                        117,261
                        
                        
                        
                        132,913171,010
                        
                        
                        
                        210,901




Long-Term
Loans from Banks and other Financial Institutions




The
following table sets forth the principal terms of our long-term loans from banks
and other financial institutions:




December 31
                                        
                                        
                                        Annual2007
                                        
                                        
                                        2008
                                        
                                        
                                        Interest Rate
                                          (1)NISin thousands
                                        
                                        
                                        %In
      Israeli currency:Linked
      to the Israeli CPI (2)
                                        
                                        
                                        189,851
                                        
                                        
                                        
                                        113,880
                                        
                                        
                                        
                                        5.1Unlinked
      and bearing a fixed interest rate (3)
                                        
                                        
                                        48,750
                                        
                                        
                                        
                                        305,456
                                        
                                        
                                        
                                        5.5Unlinked
      and bearing a variable  interest rate (4)
                                        
                                        
                                        180,897
                                        
                                        
                                        
                                        131,151
                                        
                                        
                                        
                                        4.6Total
                                        
                                        
                                        419,408
                                        
                                        
                                        
                                        552,487Less
      - current maturities
                                        
                                        
                                        117,261
                                        
                                        
                                        
                                        132,913302,237
                                        
                                        
                                        
                                        419,574


(1)
              Weighted
      average rate as of December 31,
2008.




(2)
              As of December 31,
      2008, includes approximately NIS 45 million at a weighted average interest
      rate of4.3% and the balance of approximately NIS 69 million at a weighted
      average interest rate of
5.6%.




(3)
              As
      of December 31, 2008, includes NIS 215 million at an interest rate of 4.8%
      and the balance of approximately NIS 90 million at a weighted average
      interest rate of 7%.




(4)
                As of December 31,
      2008, includes approximately NIS 50 million at a weighted average interest
      rate of4.7%, approximately NIS 61 million at a weighted average interest
      rate of 4.8%, and the balance of approximately NIS 22 million at a
      weighted average interest rate of
4%.




Debentures




The following table summarizes
outstanding debentures in 2007 and 2008 of the Company and of our subsidiary,
BSRE, of which we owned 78.45% of the shares as ofJune 15,
2009:


79




December 312007
                  
                  
                  2008NIS in thousandsConvertible
      debentures:Issued by the
      Company
                  
                  
                  77,295
                  
                  
                  
                  44,267Issued by BSRE
                  
                  
                  109,342
                  
                  
                  
                  112,086186,637
                  
                  
                  
                  156,353Less
      - current maturities
                  
                  
                  -
                  
                  
                  
                  25,956186,637
                  
                  
                  
                  130,397Other
      debentures:Issued by the
      Company
                  
                  
                  185,769
                  
                  
                  
                  199,585Issued by BSRE
                  
                  
                  633,108
                  
                  
                  
                  786,259818,877
                  
                  
                  
                  985,844Less
      - current maturities
                  
                  
                  69,859
                  
                  
                  
                  -749,018
                  
                  
                  
                  985,844




In
addition, Naaman, our subsidiary through Bee Group, has outstanding convertible
debentures, which as of December 31, 2007 and December 31, 2008, had a principal
balance of NIS 6.2 million and NIS 171,000, respectively.




Blue Square
Debentures




In August 2003, we issued to
institutional investors NIS 400 million in aggregate principal amount of
unsecured 5.9% debentures, half of which (Series B) are currently convertible
into our ordinary shares.  All the debentures are linked (principal
and interest) to the Israeli CPI, but in the event the Israeli CPI is less than
the base index (index known at date of issuance), the amount of the debentures
will not be adjusted below the base index.




Blue
Square Series A Debentures




The
principal of the Series A Debentures is repayable in three equal annual
installments on August 5 of each of the years 2012 to 2014, and the interest is
payable semiannually.  Notwithstanding the above, under the terms of
the Debentures, on August 5 of each of the years 2006, 2008 and 2010, the
holders of the Series A Debentures were entitled to early redemption of the
principal provided that on each of such dates we do not repay more than one
third of the par value of the Series A Debentures outstanding as of that
date.  No Series A Debentures have been redeemed to
date.


80


Blue Square Series
B Debentures




The
principal of the Series B Debentures is repayable in three equal annual
installments on August 5 of each of the years 2007, 2009 and 2011, and the
interest is payable semiannually.  The Series B Debentures are
convertible into our ordinary shares at a conversion ratio that is subject to
adjustment in the event of distribution of bonus shares and cash dividends and
the issuance of rights.  As of June 15, 2009, each NIS 20.095 par
value of debentures was convertible to one ordinary share of 1 NIS par value.
This conversion ratio is after adjustment for cash dividends distributed from
the date of issuance of the Series B Debentures until June 15, 2009. As of June
15, 2009, the remaining principal balance of the Series B Debentures was
approximately NIS 33.5 million.




Other
terms of the Blue Square Series A and Series B Debentures




The terms
of the debentures (Series A and Series B) provide that in the event that our
ordinary shares are delisted from trading on the TASE, and/or in the event that
our ordinary shares are no longer held by the public and/or in the event that
S&P-Maalot reduces our rating to BBB or lower, then within three months from
one of the abovementioned events we, subject to the then prevailing law, will
offer to acquire the debentures at a price equivalent to the price of debentures
of the same type reflecting a return of 2.5% in excess of the return on Israeli
Government debentures with an average life similar to the remaining average life
of the debentures of that series as of the date of the offer, but in no event
will the price exceed the adjusted carrying value of the debentures of that
series.





In May
2009, S&P-Maalot downgraded the rating of our debentures (Series A and
Series B) from "ilAA" to "ilA+/Stable".  According to S&P-Maalot,
the downgrade reflects the erosion of our financial position during 2008, as
evidenced by our increased debt coverage ratios, high leverage, lower
profitability, and the deterioration in our market share throughout the year,
which deterioration has been partially mitigated in 2009.  These
negative factors are somewhat offset by our strong liquidity, number two
position in Israel's retail sector, and diversified
activities.  S&P-Maalot's outlook of company is stable and
reflects S&P-Maalot's belief that we are taking measures, and will continue
to take measures, to stop the erosion of our market share, improve our financial
ratios, and avoid massive investments that can negatively affect our financial
profile and leverage.




BSRE
Debentures




In
August  2006, BRSE issued 2,500,000 BRSE ordinary shares of NIS 1
par value each, together with NIS 100,000,000 par value of registered BRSE
Series A debentures, which are convertible into BRSE ordinary shares, and
NIS 650,000,000 par value of registered BRSE Series B debentures. In
September 2008, BSRE completed the issuance of an additional NIS 125 million in
principal amount of unsecured non-convertible (Series B) debentures to
institutional investors. The terms of these debentures are identical to the
terms of the non-convertible (Series B) debentures issued by BSRE in August
2006.


81


BSRE
Series A Debentures




The BSRE
Series A debentures are to be redeemed in four equal annual installments on
August 31 of each of the years 2013 to 2016. The Series A debentures are linked
(principal and interest) to the known Israeli CPI and bear interest at an annual
rate of 6.25%, which is payable semiannually.  The Series A debentures
are convertible into BSRE ordinary shares from the date that they are first
listed for trade on the stock exchange through August 16, 2016, except during
the periods from August 17 through August 31 in each of the years 2013 to 2015.
The conversion rate is subject to adjustments in the event of distribution of
cash dividends.  Until August 31, 2008, the conversion was effected at
the rate of NIS 96.83 par value of registered Series A debentures
(following adjustments due to distributions of cash dividends) for each ordinary
share of NIS 1 par value; since that date and through August 16, 2016, the
conversion rate is NIS 281.83 par value of registered Series A debentures
(following adjustments due to distributions of cash dividends) for each ordinary
share of NIS 1 par value.




BSRE Series B
Debentures




The BSRE
Series B debentures are to be redeemed in four equal annual installments on
August 31 of each of the years 2013 to 2016. The Series B debentures are linked
to the known CPI and bear interest at an annual rate of 4.7%, which is payable
semiannually.




If, at
the time of making any redemption/payment on account of the principal and of
interest of the Series A or Series B debentures, it is found that the payment
index is less than the base index (the CPI for July 2006), BSRE is required to
make such payment according to the base index.




For
additional information on charges pertaining to the collateralized long-term
loans, see note 19 to our consolidated financial statements.




On July
27, 2006, S&P-Maalot rated the BSRE debentures (Series A and Series B) at
"ilAA-", and on March 20, 2008, S&P-Maalot confirmed this
rating.




On
September 28, 2008, S&P-Maalot rated the BSRE debentures (Series B), with an
increased principal amount of up to NIS 250 million, at
"ilAA-/Stable".




On May
27, 2009, following the recent downgrading of the rating of our own debentures
(Series A and Series B) to "ilA+/Stable", S&P-Maalot informed BSRE that it
had placed BSRE's debentures (Series A and Series B) on "credit watch
negative".  S&P-Maalot estimates that there is a significant
correlation between the rating of our debentures and the rating of BSRE's
debentures due to our significant holdings in BSRE (80% at the time of the
S&P-Maalot notice) and due to the fact that we are a major lessee of BSRE's
properties (our lease payments to BSRE generated approximately 85% of BSRE's net
operating income in 2008). S&P-Maalot informed BSRE that it will examine the
effects of the downgrading of the rating of our debentures on BSRE and will
publish its conclusions in the next few months.


82


Commitments
for Capital Expenditures




As of
December 31, 2008, we had entered into agreements for investments in
fixtures, equipment and leasehold improvements in the total amount of
approximately NIS 36 million, or $9.4 million.  We intend to finance
these investments from cash generated by our operations and from loans from
banks or other financial institutions.






C.
Research and Development, Patents and Licenses.




Not
applicable.




D.
Trend Information.




Based on
A.C. Nielsen and on data published by the Israeli Central Bureau of Statistics
of the retail sales of food, drinks and tobacco in Israel, we estimate that
approximately 37% of the total retail sales of food, beverages and tobacco in
Israel in 2008 was made by the two large chains and approximately 46% of the
estimated retail sales made by supermarkets, groceries and mini-markets in
Israel in 2008 was made by the two large chains - a percentage that is
considerably lower than the estimated market shares prevailing in Europe and the
United States.




Accordingly,
we believe that there is an opportunity for us to grow correspondingly with the
general growth of the supermarket sector in Israel.  In addition, we
believe that we have an opportunity to grow in locations where we do not have a
strong presence and in particular in the northern part of the country and in the
Jerusalem area.




The food
retailing industry has been subject to increased competition in recent
years.  Since the 2005 merger between Shufersal and ClubMarket,
another major chain, we have faced a larger competitor, many of whose stores are
characterized by the every day sale of products at low prices. Based on A.C.
Nielsen, we estimate that Shufersal's market share was approximately 36.9% of
the bar-coded market in Israel in 2008, as opposed to our own approximately
21.4% share of the bar-coded market in 2008.




In
addition, as a result of consumers’ focus on the price of products, in recent
years we and our competitors have established or expanded low-price and hard
discount store formats. In 2008, very low-priced smaller supermarket chains
continued to increase their market share and expand their presence in selected
areas in Israel, often geographically beyond their original
location.  The increased competition has led to increased downward
pressure on prices.


83


We expect the economic
slowdown in Israel to adversely affect our financial performance, among other
things, by reducing our sales and our profitability.  In addition, the
current global economic crisis and the resulting slowdown in the Israeli economy
has impacted the food retail market by affecting the buying patterns of our
customers, as more customers are shifting their purchases to low-price and hard
discount stores, which have a lower profit margin.  In response to
these trends, in August 2007, we launched our Mega In Town store format to offer
discount prices in neighborhood stores.  In addition, in December 2008
we launched our Mega Bool heavy discount store format as well as our "Mega" line
of private label goods that are sold in our "Mega Bool", "Mega In Town" and
"Mega" stores. We expect to continue to expand our low-price and hard discount
store formats in 2009 in an effort to increase our market share.




In
addition, during 2009, we plan on launching a new membership card and have
launched a new "You" Mastercard credit card as part of our "You" loyalty club,
which is designed to increase consumer traffic and encourage customers to
patronage our stores.




In the
past few years, we have witnessed a global trend of supermarkets specializing in
organic and health products.  In response to this trend, we purchased
Eden Nature in October 2007, which operates a leading supermarket chain in
Israel offering organic/health products. In 2008, we expanded the Eden Nature
chain and it now includes seven stores. We expect the Eden Nature chain to reach
ten stores by the end of 2009.




In order
to compete effectively in the food retailing market, we believe we must identify
new store locations and opportunities to expand and improve existing store
locations.  However, sales in new stores or in expanded or improved
existing stores may increase at the expense of sales in other existing stores of
ours due to geographical proximity.  As the supermarket industry
grows, the likelihood that sales of one store will adversely affect the sales of
a nearby store increases.




In 2008,
we opened 10 new stores and closed one store to compete in selective areas in
which we did not believe we had sufficient market presence, and we converted one
Mega In Town store into Shefa Shuk and six Shefa Shuk stores into Mega In Town
stores. We also converted 40 "Mega" and "Shefa Shuk" stores to the new brand
“Mega Bool”. In addition, we plan to continue to remodel some of our
supermarkets to give them a more “upscale” orientation, offering improved
product selection and increased focus on customer service.




In 2009,
we plan to open approximately 14 additional supermarkets, totaling approximately
17,000 square meters of store space, in localities whose populations are
currently under-served by supermarkets or in localities in which we do not have
sufficient market presence.In
addition, in 2009, we plan to convert approximately four "Shefa Shuk"
supermarkets stores into "Mega Bool" stores. In 2009, untilMay 31,
2009, we opened six supermarket stores.




In 2009, we are taking action to
further increase our market share of “Non-Food” and “Near-Food” products and to
offer a wider selection of these products to consumers in our stores with the
goal of increasing the portion of our customers’ overall shopping needs that are
addressed in our stores. In addition, we intend to continue our expansion into
the stand alone Non Food stores market by opening approximately nine additional
self-operating stores and seven additional stores operated by franchisees and to
capitalize on potential synergies and an internal reorganization in order to
improve our operating efficiency.


84


In 2009,
in order to improve our market share, we are looking to further broaden the
variety of products offered under our private label and to improve our
distribution capabilities by investing in two new distribution
centers.




E.      Off-Balance
Sheet Arrangements.




None.




F.   Tabular
Disclosure of Contractual Obligations.




The
following table sets forth certain information concerning our obligations and
commitments to make future payments under contracts, such as debt and lease
agreements:




Expected
      Maturity (NIS in thousands)2009
                    
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    2013
                    
                    
                    2014
      and
                      thereafter
                    
                    
                    TotalLong
      term loans frombanks (1)
                    
                    
                    132,913
                    
                    
                    
                    97,832
                    
                    
                    
                    79,791
                    
                    
                    
                    61,295
                    
                    
                    
                    44,269
                    
                    
                    
                    58,399
                    
                    
                    
                    474,499Debentures
      issued bythe Company (2) (3)
                    
                    
                    -
                    
                    
                    
                    73,089
                    
                    
                    
                    -
                    
                    
                    
                    48,725
                    
                    
                    
                    48,726
                    
                    
                    
                    48,726
                    
                    
                    
                    219,266Convertible
      Debenturesissued by the Company (2) (4)
                    
                    
                    18,311
                    
                    
                    
                    -
                    
                    
                    
                    18,311
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    36,622Non-ConvertibleDebentures
      issued by BSRE (5) (6)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    204,570
                    
                    
                    
                    613,710
                    
                    
                    
                    818,280ConvertibleDebentures
      issued by BSRE (5) (6)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    26,396
                    
                    
                    
                    79,189
                    
                    
                    
                    105,585Non-cancelable
      Long termleases
                    
                    
                    171,055
                    
                    
                    
                    170,293
                    
                    
                    
                    151,656
                    
                    
                    
                    140,542
                    
                    
                    
                    110,045
                    
                    
                    
                    286,886
                    
                    
                    
                    1,030,477Total
      contractual cashobligations
                    
                    
                    322,279
                    
                    
                    
                    341,214
                    
                    
                    
                    249,758
                    
                    
                    
                    250,562
                    
                    
                    
                    434,006
                    
                    
                    
                    1,520,916
                    
                    
                    
                    2,684,729





(1)
            The
      table above does not include payments of interest on our long-term loans
      because the actual interest payments on most of the loans are dependent on
      variable parameters, such as changes in the Israeli CPI, or variable
      interest rates which cannot be predicted at the date of this report.
      Without taking into account any changes in the Israeli CPI or changes in
      foreign currency rates and assuming the relevant variable interest rate
      will remain at its level as it was as of December 31, 2008 (5.3% per
      annum), interest payments on the long-term loans (in thousands) would be
      NIS 25,483 in 2009, NIS 18,534 in 2010, NIS 13,598 in 2011, NIS 9,226 in
      2012, NIS 5,763 in 2013, and NIS 9,711 in 2014 and
  beyond.





(2)
            These
      debentures bear interest at an annual rate of 5.9% and are linked
      (principal and interest) to the Israeli CPI, but in the event the Israeli
      CPI is less than the base index (index known at date of issuance), the
      amount of debentures will not be adjusted below the base index. Without
      taking into account any changes to the Israeli CPI, interest payments on
      the Non-Convertible Debentures (in thousands) would be NIS 12,941 in 2009,
      NIS 12,941 in 2010, NIS 8,627 in 2011, NIS 8,627 in 2012, NIS 5,752 in
      2013, and NIS 2,876 in 2014 and beyond.  Without taking into
      account any changes to the Israeli CPI, based on the principal amount of
      the Convertible Debentures as of December 31, 2008 and assuming no
      additional conversion of debentures, interest payments on the Convertible
      Debentures (in thousands) would be NIS 2,165 in 2009, NIS 1,082 in 2010
      and NIS 1,082 in 2011.  The table above does not include
      payments of interest on our debentures because the actual interest
      payments on these debentures will depend on changes in the Israeli CPI,
      which cannot be predicted at the time of this
  report.




85


(3)
            The
      principal is repayable in three equal annual installments on August 5 of
      each of the years 2012 to 2014.  Notwithstanding the above,
      under the terms of the debentures, on August 5 of each of the years 2006,
      2008 and 2010, the holders of the debentures are entitled to early
      redemption of the principal provided that on each of the said dates, we
      will not repay more than one third of the par value of the debentures
      outstanding as of that date.  The table above assumes early
      redemption of these debentures.




(4)
            Under
      the terms of these debentures, the principal is repayable in three equal
      installments on August 5 of each of the years 2007, 2009, and
      2011.




(5)
            The
      Non-Convertible Debentures and the Convertible Debentures bear interest at
      an annual rate of 4.7% and  6.25%, respectively, and are linked
      (principal and interest) to the Israeli CPI, but in the event the Israeli
      CPI is less than the base index (index known at date of issuance), the
      amount of debentures will not be adjusted below the base index. Without
      taking into account any changes to the Israeli CPI, interest payments on
      the Non-Convertible Debentures (in thousands) would be NIS 38,459 in each
      of the years 2009 to 2013, NIS 28,844 in 2014, NIS 19,230 in 2015, and NIS
      9,641 in 2016.   Without taking into account any changes to
      the Israeli CPI, based on the principal amount of the Convertible
      Debentures as of December 31, 2008 and assuming no additional conversion
      of debentures, interest payments on the Convertible Debentures (in
      thousands) would be NIS 6,599 in each of the years 2009 to 2013, NIS 4,949
      in 2014, NIS 3,300 in 2015, and NIS 1,654 in 2016.  The table
      above does not include payments of interest on our debentures because the
      actual interest payments on these debentures will depend on changes in the
      Israeli CPI, which cannot be predicted at the time of this
      report.




(6)
            The
      principal is repayable in four equal annual installments on August 31 of
      each of the years 2013 to 2016.




*
            The
      table above does not include severance payment obligations because the
      actual severance payments will depend on the dates of payment, which
      cannot be predicted at the time of this
report.




**
            The
      table above does not include a provision for uncertain tax positions in
      the amount of NIS 3.9 million.




86


ITEM
6.                   
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES




A.              Directors
and Senior Management.








Name
                      
                      Age
                      
                      PositionDavid
      Wiessman (1)
                      
                      54
                      
                      Executive
      Chairman of the Board of DirectorsYitzhak
      Bader
                      
                      63
                      
                      DirectorShlomo
      Even
                      
                      52
                      
                      DirectorDiana
      Bogoslavsky
                      
                      50
                      
                      DirectorDavid
      Alphandary (2)
      (3)
                      
                      74
                      
                      DirectorUzi
      Baram (1) (2)
      (3)
                      
                      72
                      
                      DirectorAvinadav
      Grinshpon
                      
                      37
                      
                      DirectorRon
      Fainaro
                      
                      42
                      
                      DirectorAvraham
      Meiron (2)
                      
                      70
                      
                      DirectorZeev
      Vurembrand
                      
                      58
                      
                      President
      and Chief Executive OfficerDror
      Moran
                      
                      41
                      
                      Vice
      President and Chief Financial OfficerIlan
      Buchris
                      
                      57
                      
                      Vice
      President for Planning and Maintenance DivisionGershon
      Wissman
                      
                      50
                      
                      Vice
      President TradeElli
      Levinson Sela
                      
                      42
                      
                      General
      Counsel and Corporate SecretaryMoshe
      Shatz
                      
                      61
                      
                      Head
      of Human Resources DivisionOren
      Lahat
                      
                      61
                      
                      Head
      of Real Estate Development DivisionOdelia
      Levanon
                      
                      46
                      
                      Head
      of Information Technology DivisionShay
      Lifshitz
                      
                      55
                      
                      Head
      of Trade HeadquartersShai
      Almog
                      
                      43
                      
                      Head
      of Marketing DivisionEliezer
      Gayer
                      
                      52
                      
                      “Mega”
      and “Mega In Town” ManagerRafi
      Masiach
                      
                      50
                      
                      “Mega
      Bool” and “Shefa Shuk” ManagerDany
      Magen
                      
                      65
                      
                      Head
      of Supply Chain DivisionZeév
      Stein
                      
                      56
                      
                      Chief
      Executive Officer of Blue Square Real Estate Ltd.Shmuel
      Enchel
                      
                      52
                      
                      Chief
      Executive Officer of Bee Group(1)  Member of
      the Compensation Committee.(2)  Member of the Audit
      Committee.(3)  External
      directors.




David Wiessman has served as
Executive Chairman of our board of directors from November 15, 2005 and as the
Vice Chairman of our board of directors from June 2003.  Mr. Wiessman
is also the Chairman of the board of directors of BSIP from March 12, 2007 and
the Chairman of the board of directors of BSRE from December 21,
2005.  In addition, Mr. Wiessman is currently the President and Chief
Executive Officer of Alon Israel Oil Company Ltd. and President and Joint
Executive Chairman of Dor Alon Energy In Israel (1988) Ltd., Chief Executive
Officer of Bielsol Investments (1987) Ltd., Chairman of the board of
directorsof
Alon Retail, Executive Chairman of Alon U.S.A. Energy, Inc., Director of Rosebud
Real Estate Ltd., and holds director and/or officer positions in other companies
affiliated with the foregoing Alon entities, both in Israel and the United
States. In addition, Mr. Wiessman also serves as a director in other companies
not affiliated with Alon Israel Oil Company Ltd., or with Alon USA Inc. Mr.
Wiessman is a member of the Compensation Committee of Blue
Square.


87


Yitzhak Bader has served as
our director from June 2003.  Mr. Bader is currently Chief Executive
Officer of Granot, a purchasing organization of the kibbutzim. He is also
Chairman of the board of directors of Alon Israel Oil Company Ltd. and Joint
Chairman of Dor Alon Energy In Israel (1988) Ltd., and a director in Alon
Retail, BSIP, Dor Gas Ltd., Dor Alon Operating Service Stations Ltd., Dor Alon
Gas Technologies Ltd., Alon USA Energy, Inc., Alon USA Operating, Inc., Alon USA
GP, LLC, Alon USA Capital Inc., Alon Assets Inc., Alon USA Inc., BSRE, Pizza Hut
Israel (2002) Limited Partnership, Pri-Gat Ltd., Rimon Counseling and Management
Services Ltd., Meiram Water and Infrastructures Ltd., entities under control of
Granot, and One Technologies Software (ASD) Ltd.




Shlomo Even has served as our
director since June 2003.  Mr. Even is currently an accountant and
partner of the accounting firm of Tiroshi Even, and a director of Super Sol
Bielsol Investments Ltd., Alon Israel Oil Company Ltd., Dor Alon Energy In
Israel (1988) Ltd., Rosebud Real Estate Ltd., Alon Dor Operating Service
Stations Ltd., and other companies.




Diana Bogoslavsky has served
as our director since March 2006. She has served as the Chief Executive Officer
of Mishkei Emek Hayarden and the Regional Plants since 2005. From 1996 to 2004,
Ms. Bogoslavsky served as Manager of the Economic Department of Brit Hapikuach
(the Supervision Alliance). From 2000 to 2004, Ms. Bogoslavsky also served as a
member of the management of Brit Hapikuach and as the Chairmen of the board of
directors of Jenny Company, a subsidiary of Brit Hapikuach. From 1993 to 1996,
Ms. Bogoslavsky served as Bank Mizrahi representative in Argentina. Ms.
Bogoslavsky currently serves as a director in the Union of the Kibbutzim
Industry and a director in several others companies. Ms. Bogoslavsky holds a
Masters degree in Economics and Business Management (specializing in financing)
and B.A. in Economics and Administration from Midreshet Rupin in the Hefer
Valley in Israel.




David Alphandary has served as
our external director since March 2006. He currently serves as an independent
consultant to the retail industry. From 1991 to 1999, Mr. Alphandary served as
President and Chief Executive Officer of Shufersal Ltd. and from 1982 to 1991 as
Vice President to Shufersal. From 1976 to 1982, Mr. Alphandary served as
President of Carmel Carpeting Industry in Ceasaria, Israel. He currently serves
as a director of Yafora Tavori Ltd. Mr. Alphandary holds a degree in Public
Administration from the Hebrew University in Jerusalem. Mr. Alphandary is a
member and the Chairman of the Audit Committee of Blue Square.




Uzi Baramhas served as our
external director since March 2006. He served as a member of Israel’s
parliament, the Knesset, from1977to 2001.He served asthe Minister of Tourism
of Israel from 1992 to 1996, and from February 1993 to August 1995 he served as
the Minister of Interior Affairs of Israel. He currently serves as a director of
Master Plan, a company for strategic communication consulting, and of Bank Otsar
Ha-Hayal. Mr. Baram holds a degree in Political Sciences and Sociology from the
Hebrew University in Jerusalem. Mr. Baram is a member of the Audit Committee and
the Compensation Committee of Blue Square.


88


Avinadav Grinshpon has served
as our director since January 2008. Mr. Grinshpon currently serves as Chief
Executive Officer of Memorand Management (1998) Ltd. and several other companies
controlled by Lev Levayev (the controlling shareholder of Africa Israel Group),
as the Vice Chairman of the Board of Directors of Africa Israel Group and as
well as director in several companies in the Africa Israel Group, which holds a
controlling interest in Blue Square, through its holdings in Alon Israel Oil
Company Ltd. Prior to that he served as Chief Financial Officer of Memorand
Management (1998) Ltd.  Mr. Grinshpon is a CPA, and holds a B.A.
degree in Business Administration and Accounting from the College of
Management.




Ron Fainaro has served as our
director since November 2007. Mr. Fainaro is the Chief Financial Officer of
Africa Israel Ltd., as well as a director of various Africa Israel subsidiaries.
From 2005 to 2007 he served as Executive Vice President and CFO of Ectel Ltd.
From 2004 to 2005, he served as CFO and VP Finance of Tecnomatix Technologies
Ltd. (WW Electronics and Shopfloor Divisions and the America Operation) and from
2001 to 2003 he served as CFO and VP Finance of Tecnomatix Unicam Inc. Mr.
Fainaro is a CPA and holds a B.A. degree in Accounting from Tel Aviv University
and B.Sc. degree in Physics and Materials Engineering.






Avraham Meiron has served as
our director and member of the audit committee since August 20, 2007. Mr. Meiron
is currently an independent advisor and is an external director in Africa Israel
Properties Ltd., a director in Discount Mortgage Bank Ltd., a member of the
investments committee in Clal Finance group, and a director in A.I. America
Israel Investments Ltd. From June 2003 to November 2005 Mr. Meiron served as a
director, and until October 2005 as the Vice-President and CFO, of Africa Israel
Investments Ltd.  Mr. Meiron also served as a director of Africa
Israel’s subsidiaries, including Alon Oil Company group, the controlling
shareholder of Blue Square. Mr. Meiron is a CPA and holds a degree in Accounting
from the Hebrew University of Jerusalem.




Zeev Vurembrandhas served as
our Chief Executive Officer and President since March 2008. From September 2007
to February 2008, Mr. Vurembrand served as the Deputy to the Chief Executive
Officer of The Phoenix Holding Ltd., and as the Chief Executive Officer of the
Phoenix Investment and Finance Ltd.  From 2002 to 2007 Mr. Vurembrand
served as the Chief Executive Officer (and as the Chairman of the board of
directors of various subsidiaries) of the General Health Services Group. Mr.
Vurembrand also serves as a director and the chairman of the balance sheet
committee of Israel Discount Bank Ltd., and as a director in U-Bank in Israel.
Mr. Vurembrand holds a B.Sc. degree in Industrial Engineering and Management
from the Technion (the Israeli Institute of Technology).




Dror Moran has served as our
Vice President and Chief Financial Officer, since July 2006.  Mr.
Moran is a CPA and received a Bachelor of Business, Accounting and Finance from
the College of Management Academic Studies in Tel Aviv.  Mr. Moran was
employed by Blue Square between 1997 and 2005 and his last position with Blue
Square was Deputy CFO.  Between April 2005 and June 2006, Mr. Moran
served as Chief Financial Officer and as Deputy CFO of InSightec Ltd., a
high-tech company.


89


Ilan Buchrishas served as our
Head of Planning and Maintenance Division since November 2004. Mr. Buchris,
Colonel (retired) in the Israeli Navy, holds a M.A. degree in Political Science
from Haifa University and a B.A. degree in settlement geography from Bar Ilan
University. Between 2000 and 2004 Mr. Buchris served as Authorities Coordinator
at Derech Eretz Highways (1997) Ltd.




Gershon Wissman was appointed
as our Vice President of Trade, as of March 2009.  Prior to that, he
served as our Head of Trade Division and a member of management, beginning in
August 2008. From 2002 to 2005, Mr. Wissman served as the Vice President for
Trade and Marketing and a member of management of the ClubMarket Chain. From
1992 to 2002, Mr. Wissman served in various capacities in our Trade Division,
including as Manager of the Grocery Product Category and as Manager of Store
Formats. Mr. Wissman holds a B.A. in Economics and Business from Haifa
University.




Elli Levinson-Sela, Adv. has
served as our General Counsel and Corporate Secretary since February 2006. Prior
to joining us, Mr. Levinson-Sela had more then 13 years of experience in private
legal practice of commercial, corporate and civil law. He holds a LL.B. degree
(with honors) from the
Hebrew University in Jerusalem and is a member of the Israeli Bar
Association.




Moshe Shatz has served as our
head of the Human Resources Division since November 2003. Mr. Shatz served as a
Vice President of Human Resources and Administration in the Tel-Aviv
Municipality from 1999 until today. From 1993 to 1998, he served as the manager
of personnel and administration division of UMI - Universal Motors Israel Ltd.
Mr. Shatz holds a B.A. in Political Science from Bar Ilan
University.




Oren Lahathas served as our
head of Real Estate Development Division since May 2004.  Prior to
that, he served from 1992-2003 as Head of the Stations Development Division and
a member of the managing team of Sonol Israel Ltd.




Odelia Levanon has served as
our Chief Information Officer since April 2000.  From 1998 to
2000, Ms. Levanon served as assistant director general for system
integration in Amigur.  From 1996 to 1998, Ms. Levanon was a
consultant engaged in the establishment process of Data Warehouse and is an
external lecturer in Business Administration and Exact Sciences at Tel Aviv
University. Between the years 1983 and 1996, Ms. Levanon served in the Israeli
army. During her army service between the years 1983 and 1994, Ms. Levanon
managed the establishment of large systems in a heterogeneous surrounding. From
1994 to 1996, Ms. Levanon managed the computerization of the five draft
centers of the Israeli Army, a project that won the Adams prize for management
information systems. Ms. Levanon has an M.Sc. degree in computer science, a
B.Sc. degree in mathematics and computer science, and also is a lecturer and a
candidate for a doctorate in business school.


90


Shay Lifshitz has served as
our Head Trade Headquarters since June 1, 2004.  Prior to that since
1999, Mr. Lifshitz served as Assistant to CEO.  Mr. Lifshitz holds an
MBA degree in Strategic Management from Hebrew University and a B.A. in Economic
and Business Administration from Bar Ilan University.




Shai Almog has served as our
Head of Marketing Division since June 10, 2008. Prior to that, Mr. Almog served
as Head of Marketing and Customers Relations in Clalit Health Services Ltd.,
from 2003 to 2008, and as Head of Coordination Division and CEO Consultant from
2001 to 2003. Mr. Almog holds a B.A. degree in Economic and Management and an
MBA degree, both from the Bar Ilan University.




Eliezer Gayer has served as
our "Mega" Manager since March 2009 and as our “Mega In Town” (previously
SuperCenter) Manager since September 2005.  From November 2004 to
September 2005, Mr. Gayer served as the then “Super Center” Operation Manager in
the Company, from 1999 to 2004, he served as a District Manager, from 1995 to
1999 he served as a Regional Manager and from 1989 to 1995, he served as a store
Manager.




Rafi Masiach has served as our
“Mega Bool” Manager since December 2008 (upon its launch) and as our “Shefa
Shuk” Manager since April 2008.  From September 2005 to February 2009,
Mr. Masiach served as "Mega" Manager. From November 2004 to September 2005, Mr.
Masiach served as a “Mega” Operation Manager, from 1999 to 2004, he served as a
District Manager in the Company, from 1996 to 1999, he served as a Regional
Manager, and from 1991 to 1996, he served as a store manager.  Mr.
Masiach holds a degree in Political Science and International Relations from the
Israeli Defense Force College of Command and Headquarters.




Dany Magen has served as our
Head of Supply Chain Division since November 2002. From 1997 until 2002, Mr.
Magen served as a Manager of the Distribution and Logistic Center, and from 1989
until 1997, he served as the manager of the sales and distribution division of
Unilever Israel.




Zeév Steinhas served as the
Chief Executive Officer of Blue Square Real Estate Ltd., since July 2006. Mr.
Stein is currently also the Deputy to the Chief Executive Officer of Dor Alon
Energy In Israel (1988) Ltd. (25% of his working time) and also serves as a
director in various companies affiliated with Alon Group.  Until
December 2004, Mr. Stein served as Vice President of Planning and Development in
Alon Israel Oil Company Ltd.  Mr. Stein holds a B.Sc. degree in Civil
Engineering and a degree in Architecture and Urban Design Planning from the
Technion (the Israeli Institute of Technology) in Haifa.




Shmuel Enchel has served
as the Chief Executive Officer of Bee Group since September 2008. From
1995 to 2007, Mr. Enchel served as the Chief Executive Officer of Ten
Petroleum Company Ltd.  Between 1994 and 1995, he
served as the Chief Executive Officer of Prostiv Ltd.




Termination
of Office




Uri Falach served as our Chief
Operating Officer and Vice-President for Trade until
August  2008.


91


Arrangements
for the Election of Directors




As of
June 15, 2009, Alon Retail owned approximately 70.65% of our ordinary shares. So
long as Alon Retail continues to own beneficially more than 50% of our
outstanding ordinary shares and voting power, it will be able to control the
outcome of matters requiring shareholder approval that do not require a special
majority, including the election of all Blue Square directors, other than Blue
Square's two external directors whose election, under the Israeli companies law,
requires that at least one-third of the non-controlling shareholders who
participate in the vote, vote for their nomination, or that the total number of
shares of non-controlling shareholders voted against their nomination does not
exceed one percent of the aggregate voting rights in the company.






B.              Compensation.




The
following table sets forth the aggregate compensation we paid or accrued on
behalf of all persons who served as Blue Square directors or senior management
for services they rendered Blue Square and its subsidiaries, for the year ended
December 31, 2008.  The table also includes compensation to
individuals who ceased to serve as directors or executive officers during the
year.




Salaries,
      fees, expenses, directors’
                        fees, commissions and
    bonuses
                      
                      Pension,
      retirement
                        and similar benefitsAll
      directors, senior managementand Acting Chairman
      as a group
                      
                      $5,480,273 (NIS
      20,836,000)
                      
                      $389,268(NIS
      1,480,000)





In
addition, we recorded the sum of approximately NIS 4.1 million, or $1.1 million,
in 2008 as a compensation cost related to the options granted to our senior
management under our share option plan.




From
January until April 2008, we agreed to pay to each director (including our
external directors) other than the Chairman of the board of directors, the sum
of NIS 45,415 per year and a meeting attendance fee of NIS 1,747, which amounts
were equivalent to the amounts allowed to be paid to external directors of
companies of comparable size under the second and third supplements to the
Companies Regulations. Following an amendment to the Companies Regulations, in
April 2008, we agreed to pay to each director (including our external directors
and expert external directors) other than the Chairman of the board of
directors, the sum of NIS 97,500 per year and a meeting attendance fee of NIS
3,660, which amounts are equivalent to the amounts allowed to be paid to
external directors of companies of comparable size under the second, third and
fourth supplements to the Companies Regulations. The fees referred to above will
be adjusted from time to time based on changes to the Israeli Consumer Price
Index in the same manner as the fees described in the Regulations are adjusted.
The directors would also be entitled to reimbursement of expenses incurred by
them in connection with their service as directors.


92


We also
agreed to pay David Wiessman, our Executive Chairman of the board of directors,
a monthly payment of NIS 42,497 plus VAT commencing from November 15, 2005, the
date Mr. Wiessman became Executive Chairman of the board of
directors.  The compensation is linked to changes in Israel’s CPI
since November 2005, and is updated every three months. No additional fees would
be paid to Mr. Wiessman for attending meetings of the board of directors or any
committee of the board of directors. Mr. Wiessman is also entitled to
reimbursement of actual expenses (upon submission of receipts) incurred by him
in connection with his service as Executive Chairman of the board of
directors.  Our audit committee, board of directors and shareholders
meeting approved this arrangement.




BSRE paid
to its CEO, Mr. Zeev Stein, for the year 2008 a total payment which cost BSRE
approximately NIS 1,523,000 (including an annual bonus). Under his employment
agreement, Mr. Stein is entitled to a salary and customary fringe benefits,
including a car lease and social benefits. In addition, Mr. Stein is entitled to
severance compensation in excess of that which is required under law (200% of
required severance in the case of dismissal and 175% of required severance in
case of voluntary termination by Mr. Stein).




In March
2008, the Company granted 2,200,000 options to executive officers with an
exercise price of NIS 39.06 (unlinked) per share, in May 2008, the Company
granted 140,000 options to executive officers with an exercise price of NIS
39.06 (unlinked) per share, and in August 2008, the Company granted 100,000
options to managers with an exercise price of NIS 39.06 (unlinked) per
share.





The
vesting periods for the options are 66.7% at the end of two years from the date
of grant and the remaining 33.3% at the end of three years from the date of
grant. The options issued to executive officers and managers may be exercised
during the six month period from the end of the vesting period, and options not
exercised during this period will expire.




C.              Board
Practices




Appointment
of Directors and Terms of Officers




Our
directors, other than our external directors, are elected by our shareholders at
an annual general shareholders’ meeting and hold office until the next annual
general shareholders’ meeting which is required to be held at least once in
every calendar year, but not more than fifteen months after the last preceding
annual general shareholders’ meeting.  Until the next annual general
shareholders’ meeting, the board of directors or shareholders may elect new
directors to fill vacancies on, or increase the number of, members of the board
of directors in a special meeting of the shareholders.  Our board of
directors may appoint any other person as a director.  Any director so
appointed may hold office until the first general shareholders’ meeting convened
after the appointment and may be re-elected.


93


Pursuant
to a recent amendment to the Israeli Companies Law, 1999, one may not be elected
and may not serve as a director in a public company if he or she does not have
the required qualifications and the ability to dedicate an appropriate amount of
time for the performance of his duties as a director in the company, taking into
consideration, among other things, the special needs and size of the company. In
addition, a public company may convene an annual general meeting of shareholders
to elect a director, and may elect such director, only if prior to such
shareholders meeting, the nominee declares, among other things, that he possess
all of the required qualifications to serve as a director (and lists such
qualifications in such declaration) and that he has the ability to dedicate an
appropriate amount of time for the performance of his duties as a director of
the company. The above requirements do not apply to directors appointed prior to
September 29, 2008.




The terms
of office of the directors must be approved, under the Israeli Companies Law, by
the audit committee, the board of directors and the shareholders
meeting.  The appointment and terms of office of all our officers,
other than directors and the general manager (Chief Executive Officer), are
determined by the general manager, subject to the approval of our board of
directors, audit committee and/or compensation committee.




We and
our subsidiaries have no service contract with any of our directors that provide
for benefits upon termination of their employment as directors.




Substitute
Directors




Our
Articles of Association provide that any director may appoint another person to
serve as a substitute director and may cancel such appointment. The identity of
a substitute director requires the approval of the board of directors. Under the
Israeli Companies Law, a person who is not himself qualified to be appointed as
a director, a person who is already serving as a director or a person who is
already serving as a substitute director for another director, may not be
appointed as a substitute director. Nevertheless, a director who is already
serving as a director may be appointed as a substitute director for a committee
of the board of directors so long as (s)he is not already serving as a member of
such committee, and if the substitute director is to replace an external
director, (s)he is required to qualify as an external director and to have
either  “financial and accounting expertise” or “professional
expertise”, depending on the qualifications of the external director (s)he is
replacing. Otherwise, a substitute director cannot be appointed as an external
director.




The term
of appointment of a substitute director may be for one meeting of the board of
directors or until notice is given of the cancellation of the appointment. To
our knowledge, no director currently intends to appoint any other person as a
substitute director, except if the director is unable to attend a meeting of the
board of directors.


94


Independent
and External Directors




Israeli Companies Law
Requirements




We are
subject to the provisions of the Israeli Companies Law, which became effective
on February 1, 2000. The Minister of Justice has adopted regulations
exempting companies, like Blue Square, whose shares are traded outside of
Israel, from some provisions of the Israeli Companies Law.




Under the
Israeli Companies Law, companies incorporated under the laws of Israel whose
shares are either (i) listed for trading on a stock exchange or (ii) have been
offered to the public in or outside of Israel, and are held by the public
(Public Company) are required to appoint at least two external
directors.  The Israeli Companies Law provides that a person may not
be appointed as an external director if the person or the person’s relative,
partner, employer, someone to whom he is subordinated 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 us, any entity controlling us or any entity controlled by or
under common control with us.  The term “affiliation”
includes:




·
            an
      employment relationship;




·
            a
      business or professional relationship maintained on a regular
      basis;




·
            control;
      and




·
            service
      as an office holder, other than service as a director who was appointed in
      order to serve as an external director of a company when such company was
      about to make an initial public
offering.




Regulations
under the Israeli Companies Law, effective as of November 2006, provide for
various instances and kinds of relationships in which an external director will
not be deemed to have “affiliation” with the public company for which (s)he
serves, or is a candidate for serving as an external director.




No person
can serve as an external director if the person’s position or other business
create, or may create, conflict of interests with the person’s responsibilities
as an external director or may impair his ability to serve as a
director.  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.




Under an
amendment to the Companies Law, at least one of the external directors is
required to have “financial and accounting expertise” and the other external
director(s) are required to have “professional expertise”. Under regulations, a
director having financial and accounting expertise is a person who, due to his
or her education, experience and qualifications is highly skilled in respect of,
and understands, business-accounting matters and financial reports in a manner
that enables him or her to understand in depth the company’s financial
statements and to stimulate discussion regarding the manner in which the
financial data is presented. Under the regulations, a director having
professional competence is a person who has an academic degree in either
economics, business administration, accounting, law or public administration or
an academic degree in an area relevant to the main business sector of the
company or in a relevant area for the board position, or has at least five years
experience in a senior management position in the business of a corporation with
a substantial scope of business, in a senior position in the public service or a
senior position in the field of the company’s business.


95


Under the
amendment each Israeli public company is required to determine the minimum
number of directors with “accounting and financial expertise” that such company
believes is appropriate in light of the company’s size, the scope and complexity
of its activities and other factors.  Once a company has made this
determination, it must ensure that the necessary appointments to the board are
made in accordance with this determination. Our board of directors determined
that two directors with “accounting and financial expertise” is appropriate for
the Company.  Our board of directors currently has at least two
directors with such “accounting and financial expertise”.




External
directors are to be elected by a majority vote at a shareholders’ meeting,
provided that either (1) the majority of shares voted at the meeting,
including at least one-third of the shares of non-controlling shareholders (as
defined in the Israeli Companies Law) voted at the meeting, vote in favor of the
election of the director without taking abstentions into account; or
(2) the total number of shares of non-controlling shareholders voted
against the election of the external director does not exceed one percent of the
aggregate voting rights in the company.




The
initial term of an external director is three years and may be extended for one
additional three-year term.  Nevertheless, Regulations under the
Israeli Companies Law provide that companies, like Blue Square (whose shares are
listed for trading both on the Tel Aviv Stock Exchange and on the New York Stock
Exchange), may appoint an external director for additional three-year terms,
under certain circumstances and conditions.  External directors may be
removed only in a general meeting, by the same percentage of shareholders as is
required for their election, or by a court, and in both cases only if the
external directors cease to meet the statutory qualifications for their
appointment or if they violate their duty of loyalty to us.  Each committee
of our board of directors is required to include at least one external director
and our audit committee is required to include all of the external
directors.




David
Alphandary and Uzi Baram currently serve as Blue Square's external
directors.





New
York Stock Exchange Requirements




See below
“- Audit Committees - New York Stock Exchange Requirements” for a description of
the independence requirements for audit committee members under applicable NYSE
rules.




96




Audit
Committees




Israeli
Companies Law Requirements




Under the
Israeli Companies Law, the board of directors of a public company must appoint
an audit committee, comprised of at least three directors including all of the
external directors, but excluding a:




·
            chairman
      of the board of directors;




·
            controlling
      shareholder or his relative; and




·
            any
      director employed by or who provides services to the company on a regular
      basis.




The role
of the audit committee is to examine flaws in the business management of ours,
in consultation with the internal auditor and our independent accountants and
suggest appropriate course of action in order to correct such
flaws.  In addition, the approval of the audit committee is required
to effect specified actions and transactions with interested
parties.




An
interested party is defined in the Israeli Companies Law as a 5% or greater
shareholder, any person or entity who has the right to designate one director or
more or the general manager of ours 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
(including officers) unless at the time of approval the two external directors
are serving as members of the audit committee and at least one of whom was
present at the meeting in which an approval was granted.




New
York Stock Exchange Requirements




Under New
York Stock Exchange rules, Blue Square is required to maintain an audit
committee consisting only of independent directors.




The
independence requirements of Rule 10A-3 of the 1934 Act implement two basic
criteria for determining independence: (i) audit committee members are barred
from accepting any consulting, advisory or other compensatory fee from the
issuer or an affiliate of the issuer, other than in the member's capacity as a
member of the board of directors and any board committee, and (ii) audit
committee members may not be an "affiliated person" of the issuer or any
subsidiary of the issuer apart from his or her capacity as a member of the board
and any board committee.




The
Securities and Exchange Commission (“SEC”) has defined "affiliate" for
non-investment companies as "a person that directly, or indirectly through one
or more intermediaries, controls, or is controlled by, or is under common
control with, the person specified." The term "control" is intended to be
consistent with the other definitions of this term under the Securities Exchange
Act of 1934, as "the possession, direct or indirect, of the power to direct or
cause the direction of the management and policies of a person, whether through
the ownership of voting securities, by contract, or otherwise." A safe harbor
has been adopted by the SEC, under which a person who is not an executive
officer, director or 10% shareholder of the issuer would be deemed not to have
control of the issuer. The SEC has also provided certain limited exceptions for
an audit committee member, who also sits on the board of directors of an
affiliate to a listed issuer, so long as, except for being a director on such
board of directors, the audit committee member otherwise meets the independence
requirements for each entity.




97






The role
of the audit committee for New York Stock Exchange purposes includes assisting
the board of directors in fulfilling its responsibility for oversight of the
quality and integrity of the accounting, auditing and reporting practices of
Blue Square.




Corporate
Governance Practices




Internal
Auditor




Under the
Israeli Companies Law, the board of directors must also appoint an internal
auditor proposed by the audit committee.  The role of the internal
auditor is to examine whether our actions comply with the law, integrity and
orderly business procedure.  Under the Israeli Companies Law, the
internal auditor may not be an interested party, an office holder, or a relative
of an interested party, or an office holder, nor may the internal auditor be our
independent accountant or its representative.  We comply with this
requirement.  Mr. Gershon Lewinsky serves as our internal
auditor.




Duties
of Office Holders and Approval of Specified Related Party Transactions Under
Israeli Law




Fiduciary
Duties of Office Holders




The
Israeli Companies Law imposes a duty of care and a duty of loyalty on all office
holders of a company, including directors and executive officers.  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 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 of an office holder includes a duty to:




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




98




·
            refrain
      from any activity that is competitive with the
  company;




·
            refrain
      from usurping 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.




Under the
Israeli Companies Law, directors’ compensation arrangements require audit
committee approval, board of directors’ approval and shareholder
approval.




The
Israeli Companies Law requires that an office holder of a company promptly
disclose any personal interest that he may have and all related material
information known to him, in connection with any existing or proposed
transaction by the company.  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.  In the case of an extraordinary transaction, the office
holder’s duty to disclose applies also to a personal interest of the office
holder’s relative.  The office holder must also disclose any personal
interest held by the office holder’s spouse, siblings, parents, grandparents,
descendants, spouse’s descendants and the spouses of any of the
foregoing.




Under
Israeli law, an extraordinary transaction is a transaction:




·
            other
      than in the ordinary course of
business;




·
            other
      than on market terms; or




·
            that
      is likely to have a material impact on the company’s profitability, assets
      or liabilities.




Under the
Israeli Companies Law, once an office holder complies with the above disclosure
requirement, the board of directors may approve a transaction between the
company and an office holder, or a third party in which an office holder has a
personal interest, unless the articles of association provide
otherwise.  A transaction that is adverse to the company’s interest
cannot be approved.





If the
transaction is an extraordinary transaction, both the audit committee and the
board of directors must approve the transaction.  Under specific
circumstances, shareholders approval may also be required.  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 the majority of the directors have a personal interest
in a matter, a director who has the personal interest in this matter may be
present at this meeting or vote on this matter, but the board of directors
decision requires the shareholder approval.




99




Controlling
Shareholder Transactions and Actions




Under the
Israeli Companies Law, the disclosure requirements which apply to an office
holder also apply to a controlling shareholder of a public company and to a
person who would become a controlling shareholder as a result of a private
placement.  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 with a controlling shareholder or
in which a controlling shareholder has a personal interest, including a private
placement in which a controlling shareholder has a personal interest, and the
terms of compensation of a controlling shareholder or his relative, require the
approval of the audit committee, the board of directors and the shareholders of
the company.  The shareholders approval must include
either:




·
            at
      least one-third of the shareholders who have no personal interest in the
      transaction and who are participating in the voting, in person, by proxy
      or by written ballot, at the meeting;
or




·
            The
      total number of shares voted against the proposal by shareholders without
      a personal interest does not exceed one percent (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 – B. Related Party
Transactions.”





The
Israeli Companies Law requires that every shareholder that participates, either
by proxy or in person, in a vote regarding a transaction with a controlling
shareholder indicate whether or not that shareholder has a personal interest in
the vote in question, the failure of which results in the invalidation of that
shareholder’s vote.




However,
under Regulations, promulgated pursuant to the Israeli Companies Law, certain
transactions between a company and its controlling shareholder(s) (or the
controlling shareholder’s relative) do not require shareholder
approval.




The
Israeli Companies Law further provides that an acquisition of shares in a public
company must be made by means of a tender offer if as a result of the
acquisition the purchaser would become a holder of 45% of the voting rights of
the company, unless there is a holder of more than 45% of the voting rights of
the company or would become a holder of 25% of the voting rights unless there is
another person holding 25% of the voting rights. This restriction does not apply
to: (i) an acquisition of shares in a private placement, if the acquisition had
been approved in a shareholders meeting under certain circumstances; (ii) an
acquisition of shares from a holder of at least 25% of the voting rights, as a
result of which a person would become a holder of at least 25% of the voting
rights; and (iii) an acquisition of shares from a holder of more than 45% of the
voting rights, as a result of which the acquirer would become a holder of more
than 45% of the voting rights in the company.




100




Regulations
under the Israeli Companies Law provide that the Israeli Companies Law’s tender
offer rules do not apply to a company whose shares are publicly traded outside
of Israel, if, pursuant to the applicable foreign securities laws or stock
exchange rules, there is a restriction on the acquisition of any level of
control of the company, or if the acquisition of any level of control of the
company requires the purchaser to make a tender offer to the public
shareholders.  It is the view of the Israeli Securities Authority,
that U.S. securities laws and stock exchange rules do not impose the required
restriction on the acquisition of any level of control of a company, and
therefore the Israeli Companies Law’s tender offer rules would apply to a
company whose shares are publicly traded in the United States.




The
Israeli Companies Law further provides that a shareholder shall refrain from
oppressing other shareholders.  In addition, any controlling
shareholder, any shareholder who knows that it possesses power to determine the
outcome of a shareholder vote and any shareholder who, pursuant to the
provisions of a company’s Articles of Association, has the power to appoint or
prevent the appointment of an office holder in the company, or has any other
power over the company, is under a duty to act with fairness towards the
company.  Under the Companies Law, the laws that apply to a breach of
a contract will generally also apply to a breach of duty of
fairness.




Exemption,
Insurance and Indemnification of Directors and Officers




Office
Holder Exemption




Under the
Israeli Companies Law, a 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 (except in connection with a
distribution made by the company) if so provided in its article of association.
Blue Square’s Articles of Association so provides.




Following
approval by our audit committee and board of directors, on June 12, 2008 our
shareholders approved a resolution exempting the Company's directors and
officers, including any of the Company's controlling shareholders who serve as
directors or officers of the Company,to the fullest extent
permitted bylaw,
from liability towards the Company with respect to any damage caused or that
will be caused to the Company by its directors and officers as aresult of a breach of
their duty of care toward the Companyor following a bona fide
action taken by them in the connection with their position in the Company,
including actions taken while serving as directors or officers in another
company, in connection with their position in the Company.




BSRE had
previously approved a prospective (in advance) exemption to BSRE's directors and
officers from liability for damage resulting from a breach of his duty of care
towards BSRE in connection with actions taken in good faith in their capacity as
a director and/or officer of BSRE or in their capacity as an officer of another
company at the request of BSRE.




101




Office
Holder Insurance




The
Israeli Companies Law and our Articles of Association provide that, subject to
the provisions of the Israeli Companies 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 Blue Square or to another
      person;




·
            a
      breach of his duty of loyalty to Blue Square, provided that the office
      holder acted in good faith and had reasonable cause to assume that his act
      would not prejudice Blue Square’s
interests;




·
            a
      financial liability imposed upon him in favor of another person concerning
      an act performed by him in his capacity as an office holder;
      or




·
            a
      breach of any duty or any other obligation, to the extent insurance may be
      permitting by law.




Indemnification
of Office Holders




The
Israeli Companies Law provides that a company may indemnify an office holder for
the following liabilities or expenses imposed on him as a result of an act
performed in his capacity as an office holder of the company, provided the
company's articles of association include the following provisions with respect
to indemnification:




·
            a
      provision authorizing the company to indemnify an Office Holder for future
      events with respect to a monetary liability imposed on him in favor of
      another person pursuant to a judgment (including a judgment given in a
      settlement or an arbitrator’s award approved by the court), so long as
      such indemnification is limited to types of events which, in the board of
      directors' opinion, are foreseeable at the time of granting the indemnity
      undertaking in view of the Company’s actual business, and in such amount
      or standard as the board of directors deems reasonable under the
      circumstances. Such undertaking must specify the events that, in the Board
      of directors’ opinion, are foreseeable in view of the company’s actual
      business at the time of the undertaking and the amount or the standards
      that the board of directors deemed reasonable at the
  time;




·
            a
      provision authorizing the company to indemnify an Office Holder for future
      events with respect to reasonable litigation expenses, including counsel
      fees, incurred by an office holder or which he is ordered to pay by a
      court, in proceedings that the company institutes against him or
      instituted on behalf of the company 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 criminal
      intent;




·
            a
      provision authorizing the company to indemnify an Office Holder for future
      events with respect to reasonable litigation fees, including attorney’s
      fees, incurred by an office holder in consequence of an investigation or
      proceeding filed against him by an authority that is authorized to conduct
      such investigation or proceeding, and that resulted without filing an
      indictment against him and without imposing on him financial obligation in
      lieu of a criminal proceeding, or that resulted without filing an
      indictment against him but with imposing on him a financial obligation as
      an alternative to a criminal proceeding in respect of an offense that does
      not require the proof of criminal intent;
and




102




·
            a
      provision authorizing the company to retroactively indemnify an Office
      Holder.




On June
12, 2008, following approval of our audit committee and board of directors, our
shareholders approved amendments to our Articles of Association pertaining to
indemnification of directors and officers that reflect the provisions of the
Israeli Company Law described above.




Our
Articles of Association provide that Blue Square may undertake to indemnify an
Office Holder for obligations or expenses imposed on him as a result of an act
done in his capacity as an Office Holder in Blue Square or as a result of being
an Office Holder, in another company in which Blue Square holds shares or has
interests, as specified above.




Our
Articles of Association further provide that the aggregate amount of
indemnification (in addition to any insurance proceeds received) shall not
exceed 25% of the shareholders’ equity of the Company, as set forth in the
Company’s most recent consolidated financial statements prior to the applicable
payment of indemnification.




Limitations
on Insurance, Exemption and Indemnification




The
Israeli Companies Law and our Articles of Association provide that a company may
not exempt or 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 (a recent change to the Israeli Companies Law
      clarifies that this provision does not apply if the breach was solely as a
      result of negligence);




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




·
            any
      fine imposed on the office holder.




In
addition, under the Israeli Companies Law, indemnification of, and procurement
of insurance coverage for, our office holders must be approved by our audit
committee and board of directors and, in specified circumstances, by Blue
Square’s shareholders.  Our audit committee, board of directors and
general shareholders meeting approved in February 2001 the grant of
indemnification and exemption letters to our directors and officers, including
those directors andofficers whose term of
service ended on or after September 1, 2000.  In April 2002, the
general shareholders meeting approved the grant of a new letter of
indemnification and exemption to the officers and directors of the
company.  The aggregate amount of the indemnification (in addition to
any insurance proceeds received) may not exceed 25% of our shareholders’ equity
(in U.S. dollars) as stated in our consolidated financial statements for the
year ended December 31, 2000, for all persons and events.  Under
the indemnification and exemption letters, we agreed to indemnify these
directors and officers, retroactively with respect to events occurring after
February 1, 2000, the date on which the Israeli Companies Law became
effective and prospectively, in connection with the following
issues:




103




·
            The
      issuance of securities, including the offering of securities to the public
      according to a prospectus, a circular, a private offering or any other
      manner of security offering;




·
            Any
      transaction, as defined in section 1 of the Israeli Companies Law,
      including a transfer, sale or purchase of assets or liabilities, including
      securities or the receipt of any right in any of the above, and any action
      related, directly or indirectly, to such
  transaction;




·
            An
      action, including handing over information and papers, in connection with
      sale of our shares or assets, by the
Co-Op;




·
            The
      filing of a report or announcement required by the Israeli Companies Law
      or the Israeli Securities Law, 1968, the rules and regulations of a stock
      exchange in or outside Israel, or any law of any other country pertaining
      to these issues, and/or omission to file such a report or
      announcement;




·
            Any
      change of reorganization of us, including any related decision, including
      without limiting the generality of the foregoing, splitting, dividing or
      modifying our share capital, establishment of subsidiaries or their
      liquidation or sale and issuance of
shares;




·
            Oral
      or written statements, including the expression of an opinion or a
      position conveyed in good faith by an office holder, in his capacity as
      such, during his term of office, including statements made in meetings of
      the board of directors or any
committee;




·
            An
      action in the line of business of us in relation with the following
      issues: building and planning, licensing of businesses, safety in work
      places, environment and recycling and protection of the consumer;
      or




·
            Each
      one of the circumstances stated above, all in connection with the office
      holder’s service on behalf of our subsidiaries or affiliated
      companies.




We are
obligated to indemnify a director or officer for a specific loss only if the
director or officer has not been compensated for that loss from another source,
including from proceeds of insurance policy.




We agreed
to indemnify our directors and officers to the fullest extent permissible by the
Israeli Companies Law, against all amounts they may be obligated to pay as a
result of a court decision or a settlement or an arbitrator’s award approved by
a court decision in connection with and in the scope of their activities as
directors and officers of the company and actions taken by a director or officer
as an office holder of the company or its subsidiary or affiliated
companies.




104




We will
indemnify our directors and officers for all costs or expenses, including
reasonable legal expenses, that they may incur as a result of any financial
obligation borne in connection with any threatened or pending civil proceeding
or criminal proceeding in which the directors and officers are acquitted or (to
the extent permitted by law) in which they are convicted, provided however, that
the crime for which they are convicted does not require a finding of criminal
intent.




We
further agreed to exempt these directors and officers to the fullest extent
permitted by the Israeli Companies Law from any liability towards us with
respect to any damage caused or that will be caused to the company by its
directors and officers if caused or will be caused following a breach of the
duty of care towards the company.




The
letter will not apply in respect of liability or an expense imposed in respect
of an action instituted by the Co-Op and/or by the appointed management
committee of the Co-Op or in respect of an action instituted by the Israeli
Registrar of Cooperative Societies and/or by the State of Israel in connection
with the allotment of options by us in accordance with the options allotment
scheme of 1996.




The
letter will not include exemption or indemnification in the following
cases:




1.
            A
      breach of fiduciary duty, which was acted not in good faith or that the
      officer had reasonable grounds to believe that the act would cause the
      company any harm;




2.
            A
      breach of the duty of care, which was committed intentionally or
      recklessly;




3.
            An
      act committed with the intention to realize a personal illegal profit;
      or




4.
            A
      fine or monetary composition imposed on
him.




Pursuant
to resolutions adopted by our shareholders, we obtained and will continue to
hold a directors’ and officers’ liability insurance policy.  Coverage
under our policy has been set at $30 million (including our subsidiaries,
excluding BSRE). We have purchased directors’ and officers’ liability insurance
policy for our directors and officers and those of our subsidiaries, which
includes BSIP and its subsidiaries. The insurance policy is for a period
beginning on November 30, 2008, and ending on November 30, 2009, for the maximum
coverage of $30 million per claim and in the aggregate during the policy
period.  Our audit committee, board of directors and shareholders have
approved any renewal and/or extension of the insurance policy and the purchase
of any other insurance policy, provided that any such renewal, extension or
purchase is for the benefit of Blue Square’s previous and/or current and/or
future directors and officers and on terms substantially similar to those of the
insurance policy and on condition that the premium will not increase by more
than 25% in any year, as compared to the previous year.  Our current
insurance policies comply with these terms.




105




BSRE has
obtained a separate directors’ and officers’ liability insurance policy with a
coverage of $15 million per claim and in the aggregate during the insurance
policy term (beginning on December 1, 2008 and ending on November 30,
2009).




On June
12, 2008, following approval of our audit committee and board of directors, our
shareholders approved the grant of new indemnification letters to the Company's
directors and officers (and to those who will serve as its directors and
officers from time to time). The aggregate amount of the indemnification (in
addition to any insurance proceeds received) may not exceed 25% of the Company's
equity as set forth in the Company's most recent consolidated financial
statements prior to the applicable payment of indemnification.




Under the
new indemnification letter, the Company undertook to indemnify its directors and
officers for obligations or expenses that may be imposed on them as a result of
their actions in their capacity as an office holder in the Company or as a
result of  actions in their capacity as an office holder or the holder
of any other position in another company in which the Company holds rights or is
an interested party therein (unless fulfilling the position in the other company
is not in connection with their function in the Company or at its request), as
permitted by the Company's Articles of Association.  See above "-
Indemnification of Office Holders".




Under the
new indemnification letter, the Company undertook to indemnify its directors and
officers prospectively and retroactively with respect to following
events:




·
            Issue
      of securities, including, an offering of securities to the public pursuant
      to a prospectus, private placement, tender offer or offering of securities
      in any other manner;




·
            An
      event connected with the making of an investment by the Company before,
      during and after the effecting of the investment, in the course of
      negotiations, contractual arrangement, signature, development and
      monitoring the investment, including actions performed on behalf of the
      Company as an officer, employee or observer in the corporation in which
      the investment is made;




·
            A
      transaction or arrangement, including a transfer, sale or purchase of
      assets or liabilities, and including, goods, real estate, securities, or
      rights, or the giving or receiving of a right in any one of them and any
      action connected, directly or indirectly with such transaction, and
      including a tender offer of any sort and another transaction in securities
      which the Company has issued, whether or not the Company is a party
      thereto;




106




·
            A
      report or notice filed or submitted according to any law, including, an
      event arising from the fact of the Company being a public company or
      arising from the fact of its securities having been offered to the public,
      or arising from the fact of its securities being traded on a stock
      exchange, and including, a report or notice in accordance with the
      Companies Law - 1999 or the Securities Law - 1968, or the tax laws
      including regulations or directives made pursuant thereto, or in
      accordance with laws or provisions that apply outside of Israel or a
      report or notice lodged or submitted in accordance with rules, directives
      or instructions customarily practiced on the stock exchange in Israel or
      abroad and/or failure to submit such report or
  notice;




·
            An
      act in connection with voting rights in investee
  companies;




·
            An
      act in connection with the management of market
  risks.




·
            A
      change in the structure of the Company or its reorganization or any
      resolution relating thereto, including, a merger, split, alteration of the
      capital of the Company, setting up of subsidiaries, winding-up or sale
      thereof.




·
            Action
      connected directly or indirectly with employer-employee relationships in
      the Company and/or the commercial relations of the Company, including
      employees, external contractors, customers, suppliers and service
      providers, including negotiations, entering into and implementation of
      personal employment agreements or collective bargaining agreements,
      benefits to employees, including the issue of securities to
      employees.




·
            An
      act in connection, directly or indirectly, with the sale of products,
      purchase of products, import of products, operation of branches and sites
      of the Company, safeguarding of public health and safety instructions and
      provisions.




·
            An
      act in connection with the issue or non-issue of licenses and permits for
      the Company’s activities.




·
            The
      preparation and approval of financial statements, including the approval
      of resolutions regarding the application of accounting standards and
      restatement in the financial
statements.




·
            An
      act in connection with a distribution, including, for a repurchase by the
      Company of its own securities.




·
            The
      transfer of information that is required or permissible for transfer
      according to law between the Company and/or the other companies and
      interested parties in any of them.




·
            Remarks,
      statements including the expression of a position or opinion made in good
      faith by the officer in the course of performing his function and by
      virtue of his function, and including in the framework of meetings of the
      board of directors or any of its
committees.




·
            An
      act or deed on matters of planning and building, work safety, the
      environment and recycling, public health, consumer
    protection.




107




Pursuant
to the new indemnification letter, upon issuance of the new letter, all previous
indemnification letters previously issued to each director or officer by the
Company will be cancelled, effective as of the date of approval of the indemnity
resolution. Notwithstanding, such revocation will not prejudice or derogate from
the validity of previous indemnification letters that were issued to such
director or officer by the Company, to the extent that such undertaking is valid
according to law and applies to actions with respect to the period preceding the
approval of the indemnity resolution, and provided that such entitlement to
indemnity in respect of such liability and/or expense will only be in accordance
with one of the indemnification letters.





Committees




Our board
of directors has established a compensation committee and an audit committee.
Our compensation committee, which consists of David Wiessman and Uzi Baram,
administers issues relating to employee compensation for senior
management.  Our audit committee, which consists of David Alphandary,
Uzi Baram and Avraham Meiron, examines flaws in our business management and its
approval is required to effect specified actions and transactions with
interested parties.  The audit committee also assists the board of
directors in overseeing the quality and integrity of our accounting, auditing
and reporting practices and in the approval of our financial statements. For
more information regarding the role of our audit committee see also “Item
6.  Directors, Senior Management and Employees - C. Board Practices -
Audit Committees.”




D.           Employees.




As of
December 31, 2008, we employed 7,475 employees (including employees of Bee Group
and Eden Nature), counting multiple employees sharing a single position as a
single employee, including 3,253 temporary employees. 1,054 of our employees
were employed in central management and administration and in our logistics
center and 6,421 in our stores.




As of
December 31, 2007, we employed 7,421 employees, counting multiple employees
sharing a single position as a single employee, including 3,181 temporary
employees. 1,047 of our employees were employed in central management and
administration and in our logistics center and 6,374 in our stores.




As of
December 31, 2006, we employed 6,270 employees, counting multiple employees
sharing a single position as a single employee, including 3,000 temporary
employees. 694 of our employees were employed in central management and
administration and in our logistics center and 5,576 in our stores.




108




We are
subject to labor laws and regulations in Israel.  Most of our
employees are subject to collective bargaining labor agreements. Under a Special
Collective Bargaining Agreement, referred to as the Special Agreement, from
May 1996, among the Co-Op, Blue Square, the Histadrut (General Federation
of Labor in Israel) (Histadrut), the National Committee of the Co-Op Union
Employees and the Co-Op Union, all the Co-Op employees became employees of Blue
Square.  The collective bargaining agreements in effect as of that
date apply to Blue Square as if Blue Square and these employees were originally
parties to these agreements.  Blue Square became responsible for the
payment of all employee benefits that had been accrued in respect of these
employees during the term of employment of these employees with the Co-Op, to
the extent these benefits were recorded on the Co-Op’s records.  Since
1996, we entered into new labor agreements with the Histadrut and the Co-Op
union, which determines our employees wages structure, the employment conditions
of new employees and a wage increase to the existing employees.




During
2003, we agreed to make “good will grants” to management and employees. In
August 2003, we entered into a collective bargaining arrangementwith the Histadrut and
the National Committee of the Co-Op Blue Square Employees in respect of various
grants to our employees which were already paid.  In addition under
that agreement, we agreed (i) to pay to our permanent employees 1% of any cash
dividend distributed to our shareholders, but not more than $2.5 million in the
aggregate to our employees; and (ii) in any public issuance of our shares after
the date of the agreement, our permanent employees will be entitled to purchase
up to 10% of any such offering with a 20% discount over the minimum offering
price (in the event that convertible securities will be offered, the employees
will be entitled to a discount of 20% from the exercise price or the rate of
conversion; in the event shares are offered to the public together with other
securities, employees will be entitled to a discount of 20% only on the offering
price of the shares).  With respect to such a purchase by our
employees of our shares in a public offering, we have agreed to make loans to
our employees to enable them to pay the purchase price for the shares, and these
loans are to be repaid by the employees with interest and linkage upon the sale
of the shares following the expiration of the appropriate tax holding period for
the shares or, if desired by the employee, until the earlier of five years from
the expiration of the holding period or the end of the employee’s employment
with us.




In
January 2005, we entered into a special collective bargaining arrangementwith the Histadrut and
the National Committee of Blue Square-Israel.  Under this agreement,
the parties agreed that Blue Square’s employees that started their employment on
or after January 1, 2003 (excluding stores managers and their deputies and
departments managers and their deputies) will be entitled to night shift
compensation and to compensation for working on Saturdays nights and the nights
following holidays at variable rates which are lower than the payments currently
being paid.




In April
2006, we entered into a special collective bargaining arrangementwith the Histadrut and
the employees' union (which amends a preceding general collective bargaining
agreement adopted by the Company in 1996), regarding the rights of pregnant
employees which are unable to work during their pregnancy due to medical
reasons.




In May
2006, we entered into a special collective bargaining arrangementwith the Histadrut and
the employees' union, effective as of January 1, 2006, regarding the increase of
the contributions and deductions made by employees and by the Company to a
saving fund.




109




In 2006,
we reached an understanding with the employees’ representative regarding the
increase in the number of employees (quota) who will be deemed to be permanent
employees (tenure) and shortening of the periods required for promotion. No
special written collective bargaining agreement incorporating such understanding
has been signed.




In July
2007, we entered into a special collective bargaining arrangementwith the Histadrut and
the employees' union regarding the transition of store managers from a
collective bargaining arrangementto personal employment
agreements, without prejudice their social benefits (i.e., with no less favorable
social benefits stipulated under the collective bargaining arrangement). Under
the agreement, these store managers will continue to be subject to the
applicable provisions of the collective bargaining agreement which require the
prior approval of the employees' union and the Histadrut before their dismissal.
In the event that a store manager will be transferred to more junior position,
he will once again be subject to the collective bargaining agreement, and his
compensation, rights and fringe benefits will be adjusted to his level prior to
the  transfer to a personal employment agreement.




In
February 2007, we entered into a special collective bargaining arrangementwith the Histadrut, the
employees' union and “Meitavit” (a pension funds management company) regarding
contributions and deductions made for our employees and for the provision of
pension insurance. This agreement provides, among others things, for improved
conditions and benefits to the insured employees.




In
addition, we and our employees are also subject to certain provisions of the
general collective bargaining agreements between the Histadrut and the
Coordination Bureau of Economic Organizations (including the Industrialists
Association) by virtue of an extension order of the Israeli Ministry of
Labor.  These agreements concern, among other things, the maximum
length of the work day and the work week and other conditions of
employment.




In 2007,
an extension order with respect to a general collective bargaining agreement for
pension insurance was signed by the Israeli Ministry of Industry, Trade and
Labor which require all employers in Israel to obtain pension insurance for all
their employees.




We
entered into a special collective bargaining agreement with BSIP, the Histadrut
and our employees' union, effective as of April 1, 2009 (which amends a
preceding general collective bargaining agreement adopted by the Company in
1996). The agreement provides for a wage increase of 4% (to the base salary
only) to employees who have completed or will complete 24 months of employment
with us. In addition, in light of the transfer of our retail activities to BSIP,
the agreement granted us the option to transfer some or all of our employees to
BSIP. In addition, in the event that we transfer any of our employees to BSIP,
BSIP will become responsible for the payment of all employee benefits as well as
for their rights and seniority that had been accrued in respect of these
employees during the term of employment of these employees with our company, to
the extent these benefits were recorded on our records.




110




Under an
amendment to the Employment of
Employees by Manpower Contractors Act, 1996, effective as of January 1,
2008, employees of a manpower contractor(outsourced employees)
will be deemed employees of the actual employer at which they were
stationed following nine months from the date they were stationed at such
employer, subject to certain exceptions.  Under exceptional circumstances,
the Ministry of Industry, Trade and Labor may approve the extension of this
period to a period not exceeding 15 month. When a manpower contractor employee
become an employee of the actual employer, the entire period of time that the
manpower contractor employee was stationed at the actual employer will be taken
into account for purposes of calculating his seniority for benefit and
employee-related purposes.




Israeli
law generally requires the payment by employers of severance pay upon the
retirement or death of an employee or upon termination of employment by the
employer or, in some circumstances, by the employee.  We currently
fund ongoing severance obligations by making monthly payments to pension funds,
employee accounts in a provident fund and insurance policies.  In
addition, Israeli employees and employers are required to pay specified amounts
to the National Insurance Institute, which is similar to the U.S. Social
Security Administration.  Since January 1, 1995, these amounts
also include payments for national health insurance payable by
employees.  Most of our employees are covered by a pension
fund.  Our senior employees are covered by general and/or individual
life and pension insurance policies providing customary benefits to employees,
including retirement and severance benefits.






E.              Share
Ownership.




As of
June 15, 2009, other than indirect ownership through Alon Retail, none of our
directors or officers owned more than 1% of our outstanding equity
securities.




On
January 21, 2008, we adopted a share option plan (the "Plan") for officers and
employees of Blue Square and/or its subsidiaries and/or affiliated
companies.  The total number of shares reserved for issuance under the
Plan is five million shares (including options issuable to Blue Square's Chief
Executive Officer, Mr. Zeev Vurembrand), subject to adjustments.  The
exercise price of each option will be at the fair market value per share on the
date of grant, and all exercises of options under the plan are to be on a
cashless basis.   Therefore, the actual number of shares to be
issued under the Plan will be less than five million.  As of the date
of this Annual Report, an aggregate of 2,420,500 options granted to employees
under the Plan were outstanding, with an exercise price of NIS 34.42 per share
(adjusted for 50% of the dividends paid), and 2,040,000 options granted to
executive officers and managers under the Plan were outstanding with an exercise
price of NIS 37.33 per share (adjusted for 50% of the dividends
paid).





The
vesting periods for the options granted are 66.7% at the end of two years from
the date of grant and the remaining 33.3% at the end of three years from the
date of grant. The options issued to executive officers and managers may be
exercised during the six month period from the end of the vesting period, and
options not exercised during this period will expire.  The options
issued to employees may be exercised during the 30 days from the end of the
vesting period, and options not exercised during this period will
expire.




111




The Plan
expires three years from the date of first grant of options under the Plan,
which was on March 24, 2008.  Unless otherwise decided by the
Company's Board of Directors or a committee thereof, options granted under the
Plan will vest and be exercisable pursuant to the time schedule set out below on
condition that the option holder will be employed by the Company, a Company
subsidiary or a company controlled by the Company on the date of issuance and on
the applicable vesting date. Unless otherwise prescribed by the Company Board of
Directors or a committee thereof: two-thirds of the options will be exercisable
at the expiration of two years from the date of grant, and one-third of the
options will be exercisable at the expiration of the third year after date of
grant.






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 May 31, 2009, by each person or entity
known to own beneficially 5% or more 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.  Our major shareholders do not
have voting rights different from the voting rights of our other
shareholders.




Name
                  
                  Number of Ordinary
                    Shares BeneficiallyOwned
                  
                  
                  Percentage of
                    Outstanding Ordinary
                    Shares(1)Alon
      Retail
                  
                  
                  30,640,803
                  (2)
                  
                  
                  70.65
                  %Clal
      Insurance Enterprises Holdings Ltd.
                  
                  
                  3,717,225
                  (3)
                  
                  
                  8.57
                  %Menorah
      Mivtachim Holdings Ltd.
                  
                  
                  3,199,388
                  (4)
                  
                  
                  7.38
                  %


______________




(1)
            The
      percentage of outstanding ordinary shares is based on 43,372,819 ordinary
      shares outstanding as of May 31,
2009.




(2)
            Alon
      Retail Ltd. is a wholly owned subsidiary of Nissan Alon Retail Holdings
      Ltd., which is a wholly owned subsidiary of the Nissan Dor Chains Ltd.,
      which is a wholly owned subsidiary of Dor Food Chains Holdings Ltd., a
      wholly owned subsidiary of Alon-Israel Oil Company Ltd. (“Alon”). To the
      Company’s best knowledge, Alon is owned approximately 34.65% by nine
      collective acquisition entities of kibbutzim in Israel, approximately
      26.14% by Africa Israel Trade and Agencies Ltd., a subsidiary of Africa
      Israel Investments Ltd., a public company traded on the Tel Aviv Stock
      Exchange, and approximately 39.21% are held together by Bielsol
      Investments (1987) Ltd. and Mr. David Wiessman. To the Company’s best
      knowledge, Mr. Lev Leveiv is the controlling shareholder of Africa Israel.
      To the Company’s best knowledge, Bielsol Investments (1987) Ltd. is
      controlled by David Wiessman and the family of Advocate
    Biran.




112




(3)
            Includes
      shares held by Clal Finance Ltd., through its wholly owned
      subsidiaries. Excludes  12,975 ordinary shares, all of which are held
      for members of the public through, among others, provident funds and
      mutual funds, which are managed by companies controlled by Epsilon
      Investment House Ltd., an indirect subsidiary of IDB Development, Clal
      Finance Ltd. is a majority owned subsidiary of Clal Insurance Enterprises
      Holdings Ltd. ("Clal").  Clal is a majority owned subsidiary of
      IDB Development Corporation Ltd., (" IDB Development") an
      Israeli corporation, which is a subsidiary of IDB Holding
      Corporation Ltd. ("IDB Holdings"), an Israeli public
      corporation.  Mr. Nochi Dankner, Mrs. Shelly Bergman, Mrs.
      Ruth Manor , Izhak Manor, Mr. Avraham Livnat and Mr. Zur Davush may,
      by reason of their interests in, and relationships among them with
      respect to, IDB Holdings, be deemed beneficial owner of and to share the
      power to vote and dispose of, the Clal shares owned beneficially by
      Clal.





(4)
            Includes
      shares held by Menora Mivtachim Insurance Ltd., Menora Mivtachim Finance
      Ltd., Menora Mivtachim Pensions Ltd., Menora Mivtachim Gemel Ltd., and
      Menora Mivtachim Mutual Funds Ltd. To the Company’s best knowledge, Menora
      Mivtachim Holdings Ltd. ("Menora Holdings") is an Israeli public company.
      Approximately 61.9% of Menora Holdings outstanding shares are held
      directly and indirectly by Menachem Gurevitch and the remaining of the
      outstanding shares are held by the public. Menora Mivtachim Insurance Ltd.
      and Menora Mivtachim Finance Ltd. are wholly owned subsidiaries of Menora
      Holdings. Menora Mivtachim Pensions Ltd. is a wholly owned subsidiary of
      Menora Mivtachim Insurance Ltd. Menora Mivtachim Gemel Ltd. and Menora
      Mivtachim Mutual Funds Ltd. are wholly owned subsidiaries of Menora
      Mivtachim Finance Ltd.




The
      shares reported as beneficially owned by Menora Holdings, Menora
      Insurance, Menora finance, Mivtachim Pension, Menora Gemel and Menora
      Mutual Funds are held for members of the public through, among others,
      provident funds, mutual funds, pension funds and insurance policies which
      are managed by Menora Insurance, Menora finance, Mivtachim Pension, Menora
      Gemel and Menora Mutual Funds, all of which are subsidiaries of Menora
      Holdings, each of which operates under independent management and makes
      independent voting and investment
decisions.




As of May
31, 2009, Blue Square had approximately 33 shareholders of record with a United
States address. As of May 31, 2009, these United States record holders held
approximately 801,976 ordinary shares in the form of ADSs, representing
approximately 1.8% of our then outstanding share capital.




Alon
Retail (formerly Bronfman-Alon) acquired a 78.1% interest in Blue Square from
the Co-Op in June 2003.  As of May 31, 2009, Alon Retail Ltd., owned
approximately 70.65% of Blue Square’s ordinary shares.




113




B.           Related
Party Transactions.




Procurement
Agreement with Dor Alon Stations




Dor Alon
Service Station Operation Ltd., a subsidiary of Dor-Alon Energy In Israel (1988)
Ltd., which is controlled by Alon Israel Oil Company Ltd.) (hereinafter:
“Dor-Alon Stations”), operates convenience stores in fuel service stations and
also in a number of cities in Israel that sell various food and “Non-Food”
products.  Under the terms of the agreement between us and Dor Alon
Stations, we agreed to procure products that will be supplied to the convenience
stores, either directly from suppliers or from our distribution
center.  In consideration of the procurement of products, Dor Alon
Stations has agreed to pay us (i) for products sent directly from suppliers, an
amount equal to the cost of such products to us as determined under the
Procurement Agreement plus 2%, and (ii) for products sent from our distribution
center, an amount equal to the cost of such products to us as determined under
Procurement Agreement plus 2.75%, in each case plus VAT.  The cost of
the products to us will be audited by our independent public
accountants.  In the event that our revenues generated from the
Procurement Agreement minus related expenses from the sale of products to Dor
Alon Stations is less than NIS 1 million linked to the Israeli consumer price
index in any year without VAT, Dor Alon Stations will pay us additional amounts
in order that our income from such year will reach such NIS 1 million
amount.  To secure Dor Alon Station’s payment and other obligations to
us under the Procurement Agreement, Dor Alon agreed to provide us with a
floating lien or pledge, unlimited in amount, on all inventory in the
convenience stores, subject to any legal prevention, and Dor Alon Energy In
Israel (1988) Ltd. and Alon Israel Oil Company Ltd, the controlling shareholders
of Dor Alon Stations, will guarantee all obligations of Dor Alon Stations under
the agreement.




The term
of the Procurement Agreement is for five years commencing from March 1, 2004,
and will automatically be extended for additional one-year periods unless either
party gives notice to the other party of its desire to terminate the Procurement
Agreement 90 days prior to the expiration of the term of the Procurement
Agreement or such year, as the case may be. However, (i) either party may
terminate the Procurement Agreement on 90 days’ notice given at any time after
24 months have elapsed from the date the Procurement Agreement is effective, and
(ii) Dor Alon Stations may terminate the Procurement Agreement on 180 days’
notice with respect to particular stores in the event of the “economic failure”
(a situation on which the parties must agree) and closure of such convenience
store by Dor Alon Stations as a result of such “economic failure”.




In
addition, with respect to convenience stores located in Dor Alon fuel service
stations that are operated by third parties, we have agreed that upon Dor Alon’s
request, we may enter into separate agreements with respect to such stores with
the third party operators of such stores on substantially similar terms as the
Procurement Agreement described above.  Dor Alon Energy In Israel
(1988) Ltd. and Alon Israel Oil Company Ltd. would also guarantee the
obligations of such third party operators and Dor Alon Stations, under these
related separate agreements.




114




Transactions
with Dor Alon in Connection with Establishment of a Joint Loyalty
Plan




On
November 29, 2005, we entered into the following agreements with Dor Alon Energy
In Israel (1988) Ltd. (“Dor Alon”):




(i) an
agreement establishing a joint loyalty plan for the benefit of Blue Square's and
Dor Alon’s customers, formed as a partnership to be held 75% by Blue Square and
25% by Dor Alon (the “Loyalty Plan”).  Pursuant to the agreement, the
partnership is governed by a managers board (the “Board”), which is comprised of
six (6) members, four (4) of whom appointed by the Company (one of whom serves
as the chairman of the Board), and two (2) of whom are appointed by Dor
Alon;




(ii) an
agreement under which Blue Square and Dor Alon purchased 49% of the shares of
capital stock of Diners Club Israel Ltd. (“Diners Israel”) from Credit Cards for
Israel Ltd. (“CAL”) for a total consideration of NIS 21.3 million (of which NIS
15.6 million was paid by us).  The purchased shares were allocated
36.75% to Blue Square and 12.25% to Dor Alon.  The consideration was
funded through a non-recourse loan granted by CAL to the Company and Dor Alon.
The loan is for a period of eight years, is linked to the CPI and bears interest
in an annual rate of 6%. The loan is to be repaid in a single payment at the end
of the period. Repayment of the loan is secured only by the acquired
shares.




Under the
agreement, the Company and Dor Alon are entitled to share with CAL the net
income of Diners Israel in connection with the activities of the credit cards
bearing the "You" name based on their respective ownership interests in Diners
Israel.  The percentage of the net income of Diners Israel in
connection with its other credit card activities (i.e., those activities
outside the Loyalty Plan) to be allocated to the Company and Dor Alon is to be
determined based on the number of "activated" credit cards (as defined in the
agreement) issued to members of the Loyalty Plan from time to time, so long as
certain target numbers of such issued credit cards are met.  In the
event such target numbers are not met, the Company and Dor Alon may, during the
first three years following the issuance of the first Diners Israel credit card
to a member of the Loyalty Plan (the "Issuance Date"), purchase the right to the
net income of Diners Israel arising from such other activities through a
one-time payment.




The
Company and Dor Alon may terminate the agreement by returning the purchased
shares back to CAL on the fourth anniversary of the Issuance Date and canceling
the CAL Loan.  Under certain other circumstances, each of the Company
and Dor Alon on the one hand, and CAL on the other hand, has the right to
terminate the agreement.  Upon such termination, the Company and Dor
Alon are required to repay the CAL loan by returning the purchased shares to CAL
and receive 49% of any increase in the value of Diners Israel that occurred
since the Issuance Date.  These circumstances include the following
events: (i) if certain target numbers of issued Loyalty Plan credit cards are
not met by the fourth or sixth anniversary of the Issuance Date, or (ii) the
Loyalty Plan ceases to function or the customer club agreement (referred to in
clause (iii) below) is terminated.  In addition, the Company and Dor
Alon have the option to terminate the agreement and repay the CAL Loan in kind
by returning to CAL the purchased shares in the event that the representations
made by Cal or Diners Israel in the agreement are breached; and




115




(iii) an
agreement among Blue Square and Dor Alon, on one hand, and Diners Israel, on the
other hand, pursuant to which the Loyalty Plan offers to its members a Diner
Club Israel credit card bearing the name “You”. The agreement determines, among
other things, the allocation of costs between the parties with respect to the
costs of attracting new customers to the Loyalty Plan, mailing and advertising
costs, including the participation of Diners in the advertising budget of the
Loyalty Program, and clearing fees.




See “Item
4. Information on The Company - B. Business Overview - Marketing”.




In April
28, 2009 we entered into a supplement to the above
agreements.  Under the supplement to the agreements, the
parties agreed that commencing April 15, 2009, in addition to the "You" Diners
Club credit card, a "You" Mastercard credit card which will also
be issued by CAL. Under this agreement, CAL will provide operational
and managing services in exchange to the same consideration as were determined
in the original agreement with respect to the "You" Diners
Club credit card.   The parties agreed that for purposes of
sharing with CAL the net income of Diners Israel, the termination
rights of the parties under the agreement and otherwise, the activities of
the "You" Mastercard credit card will be treated in the same manner as
the "You" Diners card.




Arrangements
between Blue Square and various subsidiaries




Arrangements
with Bee Group





On
December 31, 2008, we invested approximately NIS 25 million ("Investment
Amount") in the Bee Group for a total of 7,058 Bee Group's Redeemable Preferred
Shares in a purchase price of  NIS 3,542.36 per share. The Redeemable
Preferred Shares have a priority for any dividends or other distribution made by
the Bee Group to its shareholders (the "Dividend Preference") of up to the
Investment Amount to be increased annually by an amount equal to 7.5% of the
Investment Amount minus dividends paid to us on account of our Redeemable
Preferred Shares. Upon payment of the Dividend Preference, the Redeemable
Preferred Shares will automatically convert into Deferred Shares, which will
have no rights.  Prior to conversion into Deferred Shares, subject to
necessary corporate approvals of the Bee Group, we have the right to convert our
Redeemable Preferred Shares into ordinary shares of the Bee Group on a
one-for-one basis.  In the event of an initial public offering of the
Bee Group, subject to approval of the directors and shareholders of the Bee
Group, we have the right to redeem our Redeemable Preferred Shares for an amount
equal to Investment Amount minus dividends paid to us on account of our
Redeemable Preferred Shares.


116


Arrangements
among Blue Square, BSIP and Hyper Hyper





Below is
a description of agreements entered into between us, BSIP and Hyper
Hyper.  As of November 3, 2008, we are the sole shareholder of BSIP
(and indirectly, of Hyper Hyper).




On October 11, 2005, we entered into
a general services framework and expenses allotment agreement with BSIP and
Hyper Hyper (the “Agreement”). The Agreement was for an initial term of five
years and under its terms was to automatically extend for three additional
five-year terms unless terminated by one of the parties not less than six months
prior to the end of the term or the extension, as the case may be (other than
for lease of property arrangements, as described below).  The
following services and arrangement were provided under the
Agreement:




Advertisement and Marketing.
Advertisement and marketing expenses with respect to each store format are
allocated between the parties in accordance with each party’s sales at stores
operating under such store format.  Advertisement and marketing
expenses not relating to a specific store format are allocated between the
parties in accordance with each party’s aggregate store sales.




Customer
Clubs.  The Company provides management and operational
services for the existing customer clubs of the Company and Hyper Hyper (and
will provide such services to any future customer club of the Company and Hyper
Hyper).  The Company and Hyper Hyper allocate between them the
expenses and costs of operating such customer clubs.  Such allocation
differs according to the type of customer club.  In the case of the
existing customer clubs (and any similar customer club established by the
Company and Hyper Hyper in the future), the parties will allocate between the
Company and Hyper Hyper the expenses and cost of operating such customers clubs
in accordance with the aggregate customer club points awarded in each party’s
stores.  In the case of future customer clubs to be established by the
Company together with third parties or in the form of a separate legal entity,
Hyper Hyper and the Company will allocate between them the following items in
accordance with the ratio between the aggregate purchases of the members of such
customer clubs in Hyper Hyper stores, on one hand, and Company stores, on the
other hand: amounts to be contributed to such customer clubs to fund their
operations, the costs and expenses associated with operations, income attributed
to such customer clubs, and  the profits and losses arising from such
customer clubs.




In the
case of future customer clubs to be established by the Company together with
third parties or in the form of a separate legal entity, these clubs will bear
the costs of the benefits which each party will provide to the customer clubs’
members; such costs will be determined based on the sale prices of the relevant
products; provided, that any customer club benefit (in the form of discounted
purchase or gift of products) made by a cashier at the time of purchase to a
customer club member will be funded by the party that provides such
benefits.




These
provisions in connection with future customer clubs are also applicable to our
new joint Loyalty Plan - "You" with Dor Alon.




Gift Certificates; Electronic
cards.  The Company provides Hyper Hyper with services in
connection with gift certificates and electronic cards. The parties allocate the
costs derived from issuance of gift certificates and electronic cards between
them in accordance with the ratio of redemptions of the gift certificates at
each party’s stores.


117


Other services. The parties
allocate the costs and expenses of the following services (if such costs are not
attributed to specific store(s)) in accordance with their respective stores’
monthly turnover: security, cleaning, cart gathering, employees training and
guidance, and regional and brand operational management services.




Officer
Costs.  Because the Company’s CEO, controller and internal
auditor are also BSIP’s CEO, controller and internal auditor, BSIP bears its
share of the cost of their employment.




Elementary Insurance.The
parties share elementary insurance expenses (including structure insurance,
insurance for independent contractors, funds insurance, inventory insurance,
vehicle insurance, third party liability insurance, employers liability
insurance, etc.). The insurance costs and expenses are allocated between the
parties in accordance with different ratios determined by the parties depending
on the insurance involved.




Leasing of Property by the
Company. The real property that the Company leased to BSIP and/or to
Hyper Hyper has been transferred, and the related lease agreements have been
assigned, to BSRE.  See “Item 4. Information on the Company - B.
Business Overview – Our Real Estate.” and “Item 7.– B. Related Party
Transactions –Arrangements between Blue Square, BSIP and Hyper Hyper and
Arrangements between Blue Square and BSRE”




Leasing of Property to the
Company. For real property that BSIP and Hyper Hyper lease and/or may
lease to the Company, the existing arrangement among the Company, BSIP and/or
Hyper Hyper was renewed and extended in accordance with the following terms and
conditions:




·
            The
      term will be up to ten (10) years from September 1,
  2005;




·
            The
      annual rent for property used for stores will be equal to the higher of 2%
      of the annual turnover of that store or 9% of the amount invested in that
      store by BSIP and Hyper Hyper, linked and adjusted to changes in Israel’s
      consumer price index as known at the day of the investment; however, with
      regard to four specific properties, the annual rent will not be lower then
      the specific agreed amounts;




·
            The
      annual rent for property not used for stores will be 9% of the amount
      invested in that property by BSIP and Hyper Hyper, linked and adjusted to
      changes in Israel’s consumer price index as known at the day of the
      investment; and




·
            Rent
      payments will be charged on an annual
basis.




118


New lease
agreements will be entered into on the basis of the terms set forth above
provided that (i) the audit committee and the board of directors of both the
Company and BSIP will approve each new lease agreement, (ii) the term of any
such new lease agreement entered into within the ten year period commencing on
September 1, 2005 will be 10 years from the date such new lease agreement for a
particular property is executed, and (iii) the aggregate properties BSIP and/or
Hyper Hyper lease to the Company may not exceed 45,000 square
meters.




Expenses and Payments for
Proceedings:To the extent permitted by law, in the event that
either party (the “obligated party”) will be liable for any amounts related to
its business activities, whether by virtue of legal proceeding, administrative
proceeding, judgment, arbitration award, settlement agreement, administrative
penalty or any other manner, the non-obligated party will indemnify the
obligated party for the non-obligated party’s pro rata portion of such payment
in accordance with its pro rata portion of the revenues earned by both parties
in the category of activities (in the relevant period) with respect to which
such proceeding was submitted.  In the event that the relevant
activity does not yield revenues, the allocation described above between the
parties will be made in accordance with their respective quantitative share in
such activity.  In the event it is not feasible to determine the
relevant period of time, the calculation will be based on each party’s
proportional share of such activity in the previous calendar year.




In addition to the above-described
agreement the Company currently has various arrangements with BSIP and Hyper
Hyper, as described below:




Employee
Lending Agreement




Hyper
Hyper has entered into an employee lending agreement with Blue Square according
to which Blue Square agreed to make employees available to Hyper Hyper according
to Hyper Hyper’s needs.  In consideration for the use of these
borrowed employees, Hyper Hyper pays Blue Square the full amount to be made to,
or on account of, these employees according to the terms of the collective labor
agreement between Blue Square and the Histadrut.  Blue Square is
responsible for paying the salaries and other benefits to the borrowed
employees.




Service
and Management Agreements




Blue
Square acts as the exclusive purchaser for Hyper Hyper, purchasing supermarket
goods for which no mark-up is charged to Hyper Hyper.  In addition,
Blue Square provides Hyper Hyper with storage, distribution, logistics and
maintenance services, for which these companies generally pay their
proportionate share of expenses.  Under a management agreement, Blue
Square provides Hyper Hyper and its subsidiaries with administrative, management
and site selection services for which Hyper Hyper pays a fee calculated based on
its net sales, up to 2% of net sales.  The fee is subject to
modification every three years pursuant to a review by an external and
independent examiner.  The fee commencing from January 2002 was
1.95% of Hyper Hyper’s sales.  During 2005 and pursuant to a review by
an examiner, the fee rate was changed to 1.96%, and amounted to approximately
NIS 81.6 million in 2008.


119


Blue
Square provides certain services to BSIP pursuant to a management agreement in
consideration for annual management fees of NIS 100,000 linked to the March 1996
CPI.




Agreements
to Identify Store Locations




Until the
end of 2008, Blue Square and Hyper Hyper had an agreement according to which
Blue Square identified facilities suitable for the Hyper Hyper
stores.  In the event Hyper Hyper elected not to use, acquire or lease
such facilities, Blue Square could have elected to do so. Hyper Hyper had rights
to acquire or lease facilities of approximately 1,500 square meters or more with
approximately 80 parking spaces, and Blue Square had the same rights in
connection with all other facilities.




Blue
Center Agreement




Blue
Square and Hyper Hyper have an agreement for the joint operation of Blue Center
website, which is owned by Blue Square. Under this agreement, Hyper Hyper is
obligated to pay Blue Square certain amounts for its investments in Blue Center,
for the development costs and for operational costs of Blue Center, in
consideration for the use of the Blue Center website by Hyper
Hyper.




Inter-Company
Accounts




We, BSIP
and Hyper Hyper agreed to maintain inter-company accounts for day-to-day
operations which bears interest at a rate equivalent to that charged by banks on
short-term loans, provided that the rate is not lower than the monthly increase
in the CPI.  The average rate was 4.3% in 2008, 4.6% in 2007 and 6.1%
in 2006.




Other
Existing Arrangements




Other
existing arrangements currently exist among the Company and BSIP and Hyper Hyper
with respect to the allocation of costs, expenses and revenues incurred in
connection with or derived from the following areas and services: storage and
supply of products; maintenance; directors and officers insurance; use of
premises; discounts and bonuses from suppliers and other arrangements relating
to day-to-day operation. In addition, BSIP purchases from the Company meat,
grocery and vegetables products, which distributed through the distribution
center, at cost price.




Arrangements
between Blue Square and BSRE




Pursuant
to the Transfer Agreement and Split Agreement entered into by the Company and
BSRE, as described in “Item 4. Information on The Company - B. Business Overview
- Real Estate”, Blue Square transferred assets with a total book value as of
December 31, 2005 of approximately NIS 1.1 billion and liabilities with a total
book value as of December 31, 2005 of approximately NIS 759.3
million.  In consideration, BSRE issued to the Company 22,642 ordinary
shares.


120


On May 4,
2006, the Israeli Tax Authority approved our application for a ruling stating
that the transfer would receive favorable tax treatment under the provisions of
Sections 104A and 105A(2) to the Income Tax Ordinance, subject to certain
conditions, as described in " Item 4. Information on The Company - B. Business
Overview - Tax Authority Approval".




In
addition, in connection with the transfer of Company real estate assets to BSRE,
and in addition to the agreements between the Company and BSRE, the Company and
BSRE also entered into the following agreements:




Arrangement
with respect to Legal Proceeding and/or Third Party Claims relating to Certain
Transferred Assets




Pursuant
to arrangement entered on August 13, 2006, the Company and BSRE agreed that with
respect to eight specified transferred real estate properties that as of
December 31, 2005 were not free and clear from third party rights and/or claims,
the Company will use its best efforts to complete the transfer of these
properties, free and clear from any third party rights or
claims.  However, if the Company will be required or agree to return
or transfer any of the said properties to third parties as a result of their
rights and/or claims, then BSRE will waive its rights such properties and will
be entitled to receive: (i) with respect to seven of the properties, the higher
of the properties' book value or the consideration received by the Company from
the third parties for these properties and (ii) with respect to one specified
property, an amount equal to the consideration received for such property from
the third parties.




Agreements
with Respect to Properties Operated by the Company.




The
Company and BSRE entered into a lease agreement on August 13, 2006 (effective as
of January 1, 2006) with respect to the 52 supermarket stores that were operated
directly by the Company prior to December 31, 2005 (plus one property for
offices purposes).  Under this agreement, the Company leases from BSRE
these properties for an initial period of at least 10 years beginning as of
January 1, 2006. The agreement will automatically be extended for an additional
five-year term unless terminated by the Company no less than 24 months prior to
the end of the initial term. The annual rent for the initial period will be
equal to the higher of 2% of the annual turnover of that store or 9% of the
amount invested in that store by the Company (as calculated in accordance with
the agreement), which amount is linked to changes in Israel’s consumer price
index from the date of such investment.  The agreement provides for
these additional provisions:




·
            Upon
      12 months' notice, at the time of the extension of the agreement the
      Company may reduce the number of the leased properties, provided that the
      rental payments for such properties (according to the average rental
      payments for the two years preceding the extension date) does not exceed
      15% of the total rent payments for all leased properties on average for
      the two years preceding the extension
date.




121


·
            Additional
      properties may be leased by the Company under the same terms and
      conditions under the lease agreement provided that (i) the term of any
      such new lease agreement entered into during the initial ten-year period
      commencing on January 1, 2006 will be for up to 10 years from the date
      such new leased property is open for business to the public, and (ii) the
      aggregate properties that BSRE leases to the Company may not exceed 60,000
      square meters. Additional properties added may not be included in the
      leased properties reduced in the manner described in the preceding
      paragraph.




·
            The
      Company may terminate the lease of some of the leased properties prior to
      the end of the lease term by giving 12 months' prior notice; however, such
      termination is limited to a number of leased properties which have an
      aggregate area of no more than 5% of the total area of the properties that
      were leased as of January 1, 2006.




·
            BSRE
      may shorten or temporarily stop (suspend) the lease of three properties
      identified in the agreement to the extent required to develop or build on
      the land where such properties are located by giving 12 months' prior
      notice and subject to obtaining a building permit for such development or
      building at the time the Company must vacate the
  premises.





·
            BSRE
      may shorten or temporarily stop (suspend) the lease of any seven
      additional properties (five during the lease term and two during the
      extension term) to the extent required to develop or build on the land
      where such properties are located by giving 12 months' prior notice and
      subject to obtaining a building permit for such development or building at
      the time the Company must vacate the premises and on the condition that
      BSRE must bear the costs of vacating the premises and provide a substitute
      store at the location with similar characteristics at its own expense
      within 24 months of the Company vacating the
  premises.





On
January 1, 2009, as part of the reorganization of the Company's supermarket
retail activities, the Company transferred all of its supermarket retail
activities to BSIP and assigned all of its rights and obligations under this
agreement to BSIP.





Upon the
transfer by BSIP of the real estate that it holds to BSRE, the lease agreement
will be extended to a term of up to ten years commencing on the date of transfer
of the real estate. In addition, at the end of the term there will be an option
to extend for an additional term of five years under the same
terms.  See "Item 4.  Information on the Company –
D.  Our Real Estate".





Agreements
with Respect to Properties Operated by BSIP and Hyper Hyper.




On June
23, 2006, the Company entered into a lease agreement with BSIP pursuant to the
lease agreement provisions of the general services framework and expenses
allotment agreement which the Company entered with BSIP and Hyper Hyper on
October 11, 2005 (the "Lease Agreement").  The Company assigned to
BSRE all of its rights and obligations under the Lease Agreement. The underlying
properties (23 supermarket stores) were also transferred by the Company to
BSRE.


122


The Lease
Agreement provided that the annual rent for property used for stores is to be
equal to the higher of 2% of the annual turnover of that store or 9% of the
amount invested in that store (as calculated in accordance with the agreement),
which amount is linked to changes in Israel’s consumer price index from the date
of such investment. The annual rent for property not used for stores is 9% of
the amount invested by the Company which amount is linked to changes in Israel’s
consumer price index from the date of such investment. The term is for up to ten
(10) years from September 1, 2005, and rent payments are charged on an annual
basis.




Upon the
transfer by BSIP of the real estate that it holds to BSRE, the lease agreement
will be extended to a term of up to ten years commencing on the date of transfer
of the real estate. In addition, at the end of the term there will be an option
to extend for an additional term of five years under the same
terms.  See "Item 4.  Information on the Company –
D.  Our Real Estate".





Under the
Lease Agreement, new lease agreements by BSIP and Hyper Hyper are to be entered
into on the basis of the terms set forth above, provided that (i) the audit
committee and the board of directors of both parties will approve each new lease
agreement, (ii) the term of any such new lease agreement entered into within the
ten year period commencing on September 1, 2005 will be for a period of up to 10
years from the date such new lease agreement is executed for a particular
property, and (iii) the aggregate properties that BSRE leases to BSIP and/or
Hyper Hyper may not exceed 80,000 square meters.




The
forgoing lease agreements are "net lease" that is, the lessee pays all
applicable payments and charges for the possession of the leased property and
the usage during the lease period.




At BSRE's
request to clarify the implementation of lease agreements dated June 23, 2006
and August 13, 2006 between BSIP and BSRE, BSIP confirmed that in the event of a
sale or lien of any of the transferred assets, the following would
apply:





(i)         BSRE
would assign to the buyer all of  BSRE's rights and commitments
towards BSIP under the lease agreements and the following would
apply:





·
            BSIP
      would enter into a separate lease agreement with the buyer of the
      transferred asset, the terms of which would reflect the terms appear in
      the BSRE-BSIP lease agreements, with the necessary
      adjustments.





·
            The
      base rent ascribed to the transferred asset in the separate lease
      agreement will be in the amount that was determined by BSRE, as
      recommended by an independent assessor, linked to the CPI from January 1,
      2006, plus 9% of the amount invested by BSRE in the transferred asset from
      January 1, 2006 and thereafter. The rent paid by BSIP to the buyer would
      be reduced from the lease payment paid by BSIP to BSRE under their lease
      agreement.





(ii)        The
rent paid for the transferred asset would be reduced (commencing from the day of
initial payment to the buyer) from the rent paid by BSIP to BSRE for all leased
properties by BSIP prior to any of sale or lien of assets in a manner that as a
result of any sale or lien of an asset, there would be no change in the amount
of the rent paid by BSIP for all assets leased to BSIP.


123




Service
Agreement




Pursuant
to an agreement entered in August 2006, effective as of January 1, 2006, the
Company provides to BSRE (directly or through its subsidiaries) the following
services: Chairman of the board of directors services, financial and accounting
management services (including bookkeeping), computer management and maintenance
service, legal consulting and corporate secretary services, office space and
related office services, and internal audit services. In consideration for these
services, BSRE pays the Company an annual amount of NIS 2.5 million. In the
event of the appointment of a Chairman of the board of directors of BSRE which
is not an office holder of the Company, BSRE will bear the related cost, and the
consideration payable under the agreement will be reduced to NIS 2 million. In
addition, BSRE may request maintenance services and will pay additional
consideration for such services in the amount of the direct costs to the Company
plus 2%.




The
consideration was based on an estimate of the Company total costs for these
services attributable to BSRE.  The consideration is linked to changes
to the Israeli CPI (since December 2005).  Commencing from 2007, the
consideration is increased each year by an amount equal to 0.2% of the
difference between (x) the cost of BSRE assets (prior to depreciation and
amortization) ("BSRE Asset Cost") at the end of the preceding year and (y) the
BSRE Asset Cost as of December 31, 2005, linked to changes to the Israeli CPI
plus VAT. In 2008, in consideration for the foregoing services, BSRE paid the
Company an annual amount of NIS 2.7 million.




The
agreement is for an initial term of five years (as of January 1, 2006) and will
be extended from time to time upon the parties' consent for additional five-year
terms (or such other period agreed to by the parties at the extension date). The
Company may terminate the agreement during the agreement term upon six months'
prior notice.





Agreement
with respect to the Allocation of Various Insurance Expenses




Pursuant
to agreement entered on August 13, 2006, insurances obtained by BSRE, such as:
elementary insurance including, structure insurance, insurance for independent
contractors, funds insurance, third party liability insurance and employers
liability insurance will be obtained within the group policy of the Blue Square
group. The insurance costs and expenses are allocated between the parties in
accordance with different ratios determined by the parties depending on the
insurance involved.


124


Deposit
of Cash Balances Agreement




Pursuant
to the agreement entered in August 2006, BSRE may, with the Company's consent
from time to time, deposit funds with the Company and receive in return funds in
an ON CALL terms (on an on-demand basis). The amount of funds lent from each
party to the other party may not exceed NIS 200 million at any time. Under the
agreement no collateral is granted in exchange for the deposited funds. The
interest paid by each party for funds received according to this arrangement
will be at a rate equivalent to the rate that the Company is charged by banks in
such month for ON CALL credit (short-term loans) on a monthly weighted average
basis. The term of the agreement was two years from its approval by the
shareholders of BSRE (February 28, 2007), and may be terminated by either party
upon seven days' prior notice. On January 8, 2009 BSRE's audit committee and
board of directors approved an extension of the agreement for an additional two
years until February 27, 2011.




In
addition, the Company and BSRE entered into an agreement with respect to
transfer of employees from the Company to BSRE.





Ordinary
Course Transactions




From time
to time, Blue Square enters into agreements and engages in transactions in the
ordinary course of business with its subsidiaries and affiliates, such as for
the purchases of merchandise, gasoline purchase agreements, including in
connection with the operation of our gasoline station(s) and gas supply
agreements with the Alon Group, joint sales and marketing promotions and legal
consulting. Some subsidiaries enter into agreements and engage in transactions
with other subsidiaries and affiliates of Blue Square.




The terms
and conditions of all of these agreements and transactions are at
“arm’s-length.”  We intend to enter into similar agreements and to
engage in similar transactions in the future. In addition to ordinary course
agreements and transactions, Blue Square and certain of its affiliates have
entered into other agreements and transactions.




Arrangements
between BSIP and BSRE




In
connection with the reorganization of the Company's real estate activities, the
Company's wholly-owned subsidiary, BSIP, would transfer all of the real estate
property (and related leases) held by it and its subsidiaries to BSRE (the
"Proposed Real Estate Transfer").  As of January, 2009, BSIP had
received the necessary corporate approvals for the Proposed Real Estate
Transfer, and the Proposed Real Estate Transfer has been approved by BSRE's
audit committee, board of directors and shareholders.  However, as a
result of ongoing discussions between BSIP and BSRE and the Israeli Tax
Authority regarding the structure of the real estate reorganization, BSRE's
board of directors may amend the terms of the transaction until August 19, 2009,
and such amendment will be subject to BSRE shareholder approval, if it is
material.  If BSRE's board of directors does not amend the terms of
the transaction by August 19, 2009, or if the amended terms of the transaction
are not approved by BSRE's shareholders, then the transaction will be effected
according to the original terms of the transaction.


125


According
to the Proposed Real Estate Transfer, BSRE will purchase from BSIP 17 of the
Company's supermarket stores, 50% of a commercial center in Be'er Sheva that is
leased to third parties, the Company's distribution and logistics center and
warehouses and an office building used by the Company, which includes one
supermarket store.  The sale of BSIP's real estate property (and
related leases) to BSRE would be for (a) an aggregate consideration of
approximately NIS 464 million, in cash, based on an appraisal by an independent
appraiser, (b) an amount equal to the balance of the shareholder's loan which
BSIP granted to certain of its subsidiaries as of the date of the closing of the
transaction (as of February, 2009, this amounted to approximately NIS 2.0
million), and (c) certain fees.  All of BSIP's rights in connection
with such shareholder's loan would be assigned to BSRE.




BSRE
agreed to obtain financing by a financial institution to the extent necessary to
complete the transaction.  BSRE plans to finance approximately 50% of
the consideration from its existing sources and 50% by a financial institution.
BSRE is currently engaged in negotiations with a bank to obtain financing for
this transaction. In the event BSRE does not obtain the required financing prior
to closing of the transaction, BSRE will be entitled to postpone payment of up
to NIS 200 million of the consideration until April 1, 2010, during which time
this amount will bear interest at 7% per annum and be linked to the Israeli
consumer price index.




BSRE
would purchase the real estate from BSIP "as is" at the date of the closing,
with no representations or warranties made by BSIP, other than limited
exceptions.  In addition, BSIP agreed to obtain any third party
consents, to the extent necessary in order to complete the
transaction.




BSIP
agreed to pay any tax or levy in connection with the sale of the properties, and
BSRE agreed to pay the purchase tax and any other tax or levy in connection with
the purchase of the properties.  However, if the purchase tax is above
0.5% of the purchase price, then BSRE and BSIP agreed to each pay half of the
purchase tax in excess of 0.5%.  In any event, the portion paid by
BSRE will not exceed NIS 14 million.




In
addition, in connection with the transfer of BSIP's real estate assets to BSRE,
BSIP and BSRE also entered into the following agreements, subject to the
completion of the Proposed Real Estate Transfer:




Agreements
with Respect to Properties Operated by BSIP.




As part
of the Proposed Real Estate Transfer, all of the real estate property used by
BSIP prior to the Proposed Real Estate Transfer would be leased back by BSRE to
BSIP for BSIP's retail activities under terms similar to existing lease
agreements between BSRE and BSIP and existing lease agreements between BSRE and
Blue Square that were previously transferred to BSIP.


126


Pursuant
to the agreement, BSIP would lease from BSRE 16 supermarket stores, the
Company's distribution and logistics center and warehouses in Rishon Le' tzion
and an office building used by the Company, which includes one supermarket store
(the "Properties"). BSIP would lease the Properties for an initial period (the
"Initial Lease Period") of at least 10 years beginning from the closing date of
the Proposed Real Estate Transfer (the "Closing Date"). The agreement would
automatically be extended for an additional five-year term unless terminated by
written notice, by BSIP, no less than 24 months prior to the end of the Initial
Lease Period. The annual rent for the Initial Lease Period of the supermarkets
will be equal to the higher of 2% of the annual turnover of that store or 9% of
the amount invested in that store by BSRE (as calculated in accordance with the
agreement) (the "Amount of the Investment"), which amount will be linked to
changes in Israel’s consumer price index.  The annual rent during the
Initial Lease Period for assets that are not used for supermarkets will be 9% of
the amount invested in the property by BSRE which amount will be linked to
changes in Israel’s consumer price index.




The
agreement provides for these additional provisions:




·
            Upon
      12 months' notice, at the time of the extension of the agreement, BSIP may
      reduce the number of the Properties subject to the agreement, provided
      that the rental payments for such properties (according to the average
      rental payments for the two years preceding the extension date) does not
      exceed 15% of the total rent payments for all leased
      properties.




·
            Upon
      12 months' notice, BSIP may terminate the lease of some of the leased
      properties prior to the end of the Initial Lease Period, provided that the
      aggregate area of such properties does not exceed 5% of the total area of
      the properties that were leased to BSIP as of the beginning of the Initial
      Lease Period. However, in any event, such right of termination does not
      include the right to terminate the lease agreement of the distribution and
      logistics center and warehouses in Rishon Le'
  tzion.




·
            Upon
      12 months' prior notice, BSRE may shorten or temporarily suspend the lease
      of certain Properties (specified in the agreement) to the extent required
      to develop or build on the land on which such Properties are located, or
      to the extent required to sell the land on which such Properties are
      located.  Such right to shorten or temporarily suspend the lease
      of such Properties is subject to the condition that, as of the date on
      which BSIP must vacate the premises, BSRE must have obtained a building
      permit for such development or building and/or BSRE must have signed an
      agreement to sell such property, as the case may
  be.





·
            Upon
      12 months' prior notice, BSRE may shorten or temporarily suspend the lease
      of any four Properties (three during the Initial Lease Period and one
      during the extension term) to the extent required to develop or build on
      the land on which such Properties are located, subject to the conditions
      that (i) as of the date on which BSIP must vacate the premises, BSRE must
      have obtained a building permit for such development or building, and that
      (ii) BSRE must bear the costs of vacating the premises and provide a
      substitute store, at the same location, with similar characteristics at
      its own expense within 24 months of BSIP vacating the
      premises.





·
            BSIP
      will be entitled to sub-lease any of the Properties, subject to the
      condition that BSIP will remain liable for the fulfillment of all the
      provisions of the agreement, jointly and severally with the substitute
      tenant.




127


·
            BSRE
      is entitled, to add building areas on each of the Properties to the extent
      permitted by the town planning schemes which apply and/or may apply in the
      future.  In the event that, pursuant to this provision, BSRE
      plans to add building areas on the property on which the Company's
      distribution and logistics center in Rishon L'tzion is located, such
      additional building is subject to the prior consent of BSIP.  In
      addition, in the event that BSRE adds buildings to the property on which
      the Company's offices in Rosh Ha'ayin are located, then, upon six months'
      notice from the date on which it receives notice from BSRE about BSRE's
      intention to build on such property, BSIP may notify BSRE of BSIP's
      intention to lease the additional buildings under the same terms as the
      existing lease agreement, with the ten year term beginning on the date on
      which the new buildings are transferred to BSIP's
    possession.





·
            BSIP
      is solely responsible for obtaining any permits or licenses required under
      law to operate the Properties.





·
            Unless
      otherwise agreed by the parties, the lease agreement will be a "net lease"
      such that BSIP shall bear any and all payments and costs that arise in
      connection with the possession and use of the Properties during the lease
      period.





·
            In
      the event that BSIP will request to erect and operate small gas stations
      on certain of the Properties, and BSRE will agree to such request, BSRE
      will bear the costs of erecting the station, apart from equipment, as
      shall be agreed by the parties. The costs of erecting the station will be
      added to the Amount of the Investment for the purposed of determining the
      annual rent for the Properties, but the income from the sale of gas from
      such station will not be considered store turnover for purposes of
      calculating the annual rent.





·
            The
      lease agreement is subject to the following conditions (the "Conditions to
      the Lease Agreement"): (i) BSIP must obtain the necessary corporate
      approvals for completion of the transaction, (ii) BSRE must obtain the
      approval of its audit committee, board of directors, and shareholders, and
      (iii) the completion of the Proposed Real Estate Transfer.  In
      the event that the Conditions to the Lease Agreement are not met within
      six months from the date on which the lease agreement is signed, the lease
      agreement will become void. However, the board of directors of each of
      BSRE and BSIP has the right to extend this period by 60 days (each
      extension) up to a total period of 12 months from date on which the lease
      agreement is signed.





As of
January, 2009, BSIP had received the necessary corporate approvals for the
Proposed Real Estate Transfer, and the Proposed Real Estate Transfer has been
approved by BSRE's audit committee, board of directors and
shareholders.  However, as a result of ongoing discussions between
BSIP and BSRE and the Israeli Tax Authority regarding the structure of the
real estate reorganization, BSRE's board of directors may amend the terms of the
transaction, subject to shareholder approval, until August 19, 2009. 
See "“Item 7.– B. Related Party Transactions - “Arrangements between BSIP and
BSRE”".


128




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.




Board
Resolution on Dividend Distributions




Blue
Square’s board of directors has resolved that Blue Square will not distribute
dividends in any quarter if the ratio of Blue Square’s net financial obligations
(as defined by S&P-Maalot) to EBITDA for any quarter exceeds 3.5 until June
30, 2006 or exceeds 3.0 thereafter.  The board of directors also
decided that Blue Square would not distribute dividends in any quarter if the
ratio of the unencumbered fixed assets (following depreciation) and investment
property as set forth on our financial statements to financial obligations (as
defined by S&P-Maalot) for any quarter is below 120%.  These board
of directors resolutions are not the dividend policy of Blue Square and they may
be amended at any time by our board of directors.  According to our
unaudited financial reports, as of March 31, 2009, the ratio of the Company's
financial obligations to EBITDA was 3.6, and the ratio of its unencumbered fixed
assets to the financial obligations was 160%.  Thus, the Company is
currently limited in its ability to distribute dividends until the ratio of the
Company's financial obligations to EBITDA returns to 3.0 or below.




Legal
Proceedings




We
are subject to legal proceedings in connection with recognition of finance
expenses.




In
2005, the Income Tax Authority issued to the Company tax assessment orders for
the years 1999-2001 alleging that certain finance expenses in the amount of
approximately NIS 17 million are not to be recognized for tax purposes on the
basis that such expenses were associated with loans incurred for the purpose of
distributing a dividend. In 2005, the Company filed an appeal with the District
Court contesting these assessments.  In January 2009, the appeal was
accepted with the consent of all parties.


129


We
are subject to legal proceedings in connection with tax
assessments.




In July
2005, the Income Tax Authority issued a notice of a deduction assessment for the
years 2001- 2004 to the Company. The amount claimed under these assessments
totaled NIS 34 million, and primarily relates to certain benefits granted
to employees in the Company’s branches. In November 2005, several senior
employees were questioned under warning, with respect to these benefits.
Following these assessments and after the rejection of the Company's position on
the matter, Income Tax Authority issued to the Company deduction assessment
orders for the years 2001- 2004 in the amount of approximately NIS 44 million.
The Company filed appeals with the District Court contesting these assessment
orders which as of the date of this Annual Report are still
pending.  In the opinion of the Company and its advisors, the
provisions included in the Company financial statements are sufficient to cover
the potential liabilities.




In July
2007, the Israeli Tax Authority issued to the Company Value Added Tax assessment
for the years 2001- 2006 in the amounts of approximately NIS 22 million in
connection with the subject matter of the foregoing deduction assessments. The
Israeli Tax Authority did not accept most of the Company's position, although it
agreed to deduct the total amount to approximately NIS 16.3 million. On February
2009, the Company filed an appeal with the District Court, which as of the date
of this Annual Report is still pending. In the opinion of the Company and its
advisors, the provisions included in the Company financial statements are
sufficient to cover the potential liabilities.




Dispute
with Former Chairman of the Board of Directors




The Co-Op, our former controlling
shareholder, submitted a monetary claim against one of our former acting
chairman of the board of directors of Blue Square, Mr. Benny Gaon, in respect of
the benefit he derived in connection with the grant of options for shares of
Blue Square.  Mr. Gaon approached Blue Square with a demand for
receipt of indemnification, as a former officer, in connection with the above
claim in the event that he is required to repay any amounts.  The
audit committee of the board of directors of Blue Square decided to reject the
demand for indemnification.  No provision was included in the
financial statements in connection with the said demand. Mr. Gaon passed away in
2008.  In April 2009, following Mr. Gaon's passing, the plaintiff
applied to the court to dismiss the claim, and the court dismissed the
claim.




Restrictive
Trade Practices Inquiry




On
January 5, 2005, the Commissioner of the Israeli Antitrust Authority issued his
final position regarding “commercial restrictive practices between the dominant
food suppliers and the major supermarket chains.” Following a meeting with the
Commissioner in March 2005, the Commissioner delivered to us and to the other
major chains a draft of a proposed consent decree with respect to the disputed
issues.  Please see “Item 4. Information on Blue Square - B. Business
Overview - Government Regulation”.


130


The
Israeli Antitrust Authority may take actions against us in connection with our
gift certificates




In 2002,
the Commissioner of the Antitrust Authority announced that the arrangements
relating to the gift certificates issued by Blue Square and other supermarket
chains apparently constitute a restrictive arrangement pursuant to the Israeli
antitrust law.  At this stage, we cannot assess the impact of the
aforementioned announcement on our business.  Following the
announcement, we decided to cease issuing the gift certificates jointly with
other supermarket chains and are presently issuing our own gift
certificates.




We are subject to inquiries in
connection with alleged reduction by suppliers of the weight and/or contents of
packaged products




During
2006, several of our employees were questioned by a Ministry of Industry, Trade
and Labor representative with respect to the practice of various suppliers that
reduce the weight and/or contents of certain packaged products, but do not
reduce the size or change the appearance of the packages or reduce the prices of
such products.  The allegation is that these practices mislead the
consumer because they are not informed of the reduction in weight and/or content
of the products.  As of the date of this Annual Report, a number of
class actions have been filed against certain of our suppliers in connection
with the reduction of weight and/or content of products.  The Company
believes that it has acted in accordance with applicable law in this
regard.




We are subject to legal proceedings
in connection with business
licenses




As of the
date of this Annual Report, 30 of our supermarket stores and five of our Eden
Nature stores have no valid business permits/license.  In 2007, we and
some of our directors and managers were indicted in connection with business
licenses and planning and building regarding some of our supermarkets stores. As
of the date of this Annual Report, there are provisional closure orders pending
against four of our supermarket stores. We are working towards obtaining the
required permits and at the same time delaying the effectiveness of the
provisional orders until such required permits are obtained.  We
estimate that neither the temporary lack of permits nor the provisional closure
orders will have material adverse effect on our operation.




We
may be subject to a class action in connection with the Consumer Protection Law,
1981




In
February 2008 a claim was filed against Blue Square and other defendants,
including companies involved in the marketing of eggs and other food
marketing chains. The plaintiffs have requested to certify the claim as a class
action.  The claim alleged that the defendants market and/or display
for purchase eggs that are classified as "Super Fresh Eggs" which are
not subject to Israeli regulatory price controls, and are
thus minimizing the shelf space and/or display of eggs that
are subject to regulatory price controls.  According to the claim, the
defendants allegedly derive a higher profit margin from the sale of such
"Super Fresh Eggs" instead of the regulated eggs.   On August 5,
2008, at the recommendation of the court, the plaintiff applied to the court to
dismiss his claim, and the court then dismissed the claim. Furthermore, the
court determined that should the plaintiff refile the claim, he would bear the
expenses of each defendant in the refilled claim, in the sum of NIS 15.000 plus
VAT, interest and linkage.


131


We
may be subject to a class action in connection with the Restrictive Trade
Practices Law, 1988




In June
2008, a claim was filed against our subsidiary, Blue Square Chain (Hyper Hyper)
Ltd. and other defendants, in connection with the marketing of ink cartridges.
The plaintiffs have requested to certify the claim as a class
action.  The claim alleges that the defendants coordinated the prices
of certain Hewlett-Packard ("HP") ink cartridges sold by them in a manner that
allegedly constitutes an agreement in restraint of trade. According to the
claim, the defendants allegedly sell HP ink cartridges for a higher price than
the price charged for such ink cartridges by smaller retailers.  The
plaintiff's personal claim is estimated at NIS 496, and if the claim is
certified as a class action, the approximate claim against all the defendants is
estimated by the plaintiff at NIS 81 million.  The claim requests a
declaratory relief of an agreement in restraint of trade, monetary compensation
and an injunction to stop the alleged price coordination. Hyper Hyper denies all
foregoing allegations. At this preliminary stage of the proceedings, it is
unable to evaluate its likelihood of success in the proceedings, including the
likelihood that the claim will be certified as a class action.




We
may be subject to a class action in connection with the Deposit on Drink
Containers Law 1999.




During
January 2009, the Company was served with a claim and a request for approval as
a class action, in which it is being sued regarding the return of a credit
note instead of cash, in accordance with the Deposit on Drink Containers Law
1999. The Claim alleges that Blue Square has to return cash returns to customers
returning empty reusable bottles according to the law, while in fact instead of
returning cash returns, it gives the customers a credit note. The plaintiff's
personal claim is estimated at NIS 51.75, and if the claim is approved as a
class action, the approximate aggregate claim is estimated by the plaintiff at
NIS 5.8 million. The Company denies all allegations, and at this preliminary
stage of the proceedings, it is unable to evaluate the likelihood of
success in the proceedings, including the likelihood that the claim will be
certified as a class action.




Other
proceedings




In 2006,
we were indicted in connection with discrepancies between the prices appearing
on products, and the prices charged by the cash register at the point of sale.
In 2007, Blue Square, BSIP and several branches managers were convicted in a
plea bargain approved by the Court. Pursuant to the plea bargain Blue Square and
Hyper Hyper were each fined NIS 70,000, in addition to a provisional fine of NIS
25,000 (each) in the event they will breach their undertaking not to commit the
same offenses within three years. See “Item 4. Information on Blue Square - B.
Business Overview - Government Regulation”.




As of the
date of this Annual Repot two indictments were filed against our company and
Hyper Hyper regarding violation of the Consumer Protection Law,
in connection with discrepancies between the prices appearing on products, and
the prices charged by the cash register at the point of sale, way of presenting
sales and other benefits and discrepancies in prices as a result of a failure in
a certain product's bar code. As of the date of this Annual Report these
indictments are still pending in court.


132





We are
involved in various other legal or other proceedings incidental to the ordinary
course of our business.  We do not believe that any of these
proceedings, individually or in the aggregate, will have a material adverse
effect on our business, financial position or operating results.





Independent
Accountants




On June
12, 2008, Blue Square shareholders approved the reappointment of Kesselman &
Kesselman as our auditors for the year ending December 31,
2008.  Kesselman & Kesselman has no relationship with us or with
any affiliate of us, except as auditors. At a shareholder meeting scheduled for
July 9, 2009, Blue Square shareholders will vote on the reappointment of
Kesselman & Kesselman for the year ending December 31, 2009.




B.
            Significant
      Changes.




Except as
otherwise disclosed in this Annual Report, no significant change has occurred
since December 31, 2008.




ITEM
      9.
            THE
      OFFER AND LISTING




A.
            Offer
      and Listing Details.




ADSs




The
following table sets forth the annual high and low closing prices for Blue
Square’s ADSs for the five most recent full financial years as reported by the
New York Stock Exchange.





Year
                  
                  High
                  
                  
                  Low2004
                  
                  $
                  13.1
                  
                  
                  $
                  9.32005
                  
                  $
                  11.3
                  
                  
                  $
                  8.52006
                  
                  $
                  14.8
                  
                  
                  $
                  9.82007
                  
                  $
                  20.0
                  
                  
                  $
                  11.62008
                  
                  $
                  14.4
                  
                  
                  $
                  5.6




133




The
following table sets forth the quarterly high and low closing prices for Blue
Square’s ADSs for each quarter of the two most recent full financial years and
the subsequent quarterly period, as reported by the New York Stock
Exchange.




Year
                        
                        High
                        
                        
                        Low2007First
      quarter
                        
                        $
                        16.4
                        
                        
                        $
                        14.2Second
      quarter
                        
                        $
                        20.0
                        
                        
                        $
                        15.7Third
      quarter
                        
                        $
                        17.5
                        
                        
                        $
                        12.3Fourth
      quarter
                        
                        $
                        14.4
                        
                        
                        $
                        11.62008First
      quarter
                        
                        $
                        13.9
                        
                        
                        $
                        9.8Second
      quarter
                        
                        $
                        14.4
                        
                        
                        $
                        9.5Third
      quarter
                        
                        $
                        12.5
                        
                        
                        $
                        9.7Fourth
      quarter..
                        
                        $
                        9.9
                        
                        
                        $
                        5.62009First
      quarter
                        
                        $
                        7.5
                        
                        
                        $
                        5.3Second
      quarter (until June 15, 2009)
                        
                        $
                        9.2
                        
                        
                        $
                        5.8




The
following table sets forth the monthly high and low closing prices for Blue
Square’s ADSs for the last six months, as reported by the New York Stock
Exchange.




2008
                                                        
                                                        High
                                                        
                                                        
                                                        LowDecember
                                                        
                                                        $
                                                        7.8
                                                        
                                                        
                                                        $
                                                        5.62009
                                                        
                                                        High
                                                        
                                                        
                                                        LowJanuary
                                                        
                                                        $
                                                        7.5
                                                        
                                                        
                                                        $
                                                        6.3February
                                                        
                                                        $
                                                        6.8
                                                        
                                                        
                                                        $
                                                        6.2March
                                                        
                                                        $
                                                        6.3
                                                        
                                                        
                                                        $
                                                        5.3April
                                                        
                                                        $
                                                        6.9
                                                        
                                                        
                                                        $
                                                        5.8May
                                                        
                                                        $
                                                        8.7
                                                        
                                                        
                                                        $
                                                        6.9June
      (until June 15, 2009)
                                                        
                                                        $
                                                        9.2
                                                        
                                                        
                                                        $
                                                        7.6


Ordinary
Shares




The
following table sets forth the annual high and low closing prices for Blue
Square’s ordinary shares for the years 2004 to 2008 as reported by the
Tel Aviv Stock Exchange.  Shares are traded on the Tel Aviv Stock
Exchange in NIS, and the translation of the NIS to dollars has been made at the
representative exchange rate of exchange on the last day of each period, as
published by the Bank of Israel.




Year
                      
                      High
                      
                      
                      LowNIS
                      
                      
                      $
                      
                      
                      NIS
                      
                      
                      $2004
                      
                      
                      57.8
                      
                      
                      
                      13.4
                      
                      
                      
                      40.6
                      
                      
                      
                      9.42005
                      
                      
                      53.8
                      
                      
                      
                      11.7
                      
                      
                      
                      38.6
                      
                      
                      
                      8.42006
                      
                      
                      62.6
                      
                      
                      
                      13.6
                      
                      
                      
                      46.8
                      
                      
                      
                      10.22007
                      
                      
                      78.8
                      
                      
                      
                      20.5
                      
                      
                      
                      45.9
                      
                      
                      
                      11.92008
                      
                      
                      52.4
                      
                      
                      
                      13.8
                      
                      
                      
                      21.4
                      
                      
                      
                      5.6




134




The
following table sets forth the quarterly high and low closing price for Blue
Square’s ordinary shares for the quarters set forth below, as reported by the
Tel Aviv Stock Exchange.  The translation into dollars has been
made at the representative rate of exchange on the last day of each period, as
published by the Bank of Israel.




2007
                  
                  High
                  
                  
                  LowNIS
                  
                  
                  $
                  
                  
                  NIS
                  
                  
                  
                  $First
      Quarter
                  
                  
                  68.6
                  
                  
                  
                  16.5
                  
                  
                  
                  60.3
                  
                  
                  
                  14.5Second
      Quarter
                  
                  
                  78.8
                  
                  
                  
                  18.5
                  
                  
                  
                  67.3
                  
                  
                  
                  15.8Third
      Quarter
                  
                  
                  73.0
                  
                  
                  
                  18.2
                  
                  
                  
                  52.1
                  
                  
                  
                  13.0Fourth
      Quarter
                  
                  
                  58.3
                  
                  
                  
                  15.2
                  
                  
                  
                  45.9
                  
                  
                  
                  11.9





2008
                      
                      High
                      
                      
                      LowNIS
                      
                      
                      $
                      
                      
                      NIS
                      
                      
                      
                      $First
      Quarter
                      
                      
                      52.4
                      
                      
                      
                      14.8
                      
                      
                      
                      33.8
                      
                      
                      
                      9.5Second
      Quarter
                      
                      
                      46.0
                      
                      
                      
                      13.7
                      
                      
                      
                      32.5
                      
                      
                      
                      9.7Third
      Quarter
                      
                      
                      41.0
                      
                      
                      
                      12.0
                      
                      
                      
                      34.7
                      
                      
                      
                      10.1Fourth
      Quarter
                      
                      
                      34.7
                      
                      
                      
                      9.1
                      
                      
                      
                      21.4
                      
                      
                      
                      5.62009First
      Quarter
                      
                      
                      29.4
                      
                      
                      
                      7.0
                      
                      
                      
                      23.0
                      
                      
                      
                      5.5Second
      Quarter (until June 15, 2009)
                      
                      
                      36.4
                      
                      
                      
                      9.3
                      
                      
                      
                      24.9
                      
                      
                      
                      6.4




The
following table sets forth the monthly high and low closing prices for Blue
Square’s ordinary shares for the last six months, as reported by the
Tel Aviv Stock Exchange.  The translation into dollars is based
on the representative rate of exchange on the last day of each period, as
published by the bank of Israel.




2008
                  
                  High
                  
                  
                  LowNIS
                  
                  
                  $
                  
                  
                  NIS
                  
                  
                  
                  $December
                  
                  
                  32.2
                  
                  
                  
                  8.5
                  
                  
                  
                  21.4
                  
                  
                  
                  5.6





2009
                  
                  High
                  
                  
                  LowJanuary
                  
                  
                  29.4
                  
                  
                  
                  7.2
                  
                  
                  
                  24.8
                  
                  
                  
                  6.1February
                  
                  
                  28.6
                  
                  
                  
                  6.9
                  
                  
                  
                  25.5
                  
                  
                  
                  6.1March
                  
                  
                  25.6
                  
                  
                  
                  6.1
                  
                  
                  
                  23.0
                  
                  
                  
                  5.5April
                  
                  
                  28.0
                  
                  
                  
                  6.7
                  
                  
                  
                  24.9
                  
                  
                  
                  6.0May
                  
                  
                  35.6
                  
                  
                  
                  9.0
                  
                  
                  
                  28.2
                  
                  
                  
                  7.1June
      (until June 15, 2009)
                  
                  
                  36.4
                  
                  
                  
                  9.2
                  
                  
                  
                  29.3
                  
                  
                  
                  7.4




For additional information on our
ordinary shares, see “Item 10.  Additional Information - B. Memorandum
and Articles of Association - Description of Securities - Ordinary
Shares.




B.
            Plan
      of Distribution.




Not
applicable.




C.
            Markets.




Our ADSs,
each representing one ordinary share and evidenced by an American depositary
receipt, or ADR, have been traded on the New York Stock Exchange, Inc. under the
symbol “BSI” since July 1996.  The ADRs were issued pursuant to a
Depositary Agreement Blue Square entered into with The Bank of New
York.


135




On
November 2000, our ordinary shares began trading also on the Tel Aviv Stock
Exchange.




D.
            Selling
      Shareholders.




Not
applicable.




E.
            Expenses
      of the Issue.




Not
applicable.




ITEM
      10.
            ADDITIONAL
      INFORMATION




A.
            Share
      Capital.




Not
applicable.




B.
            Memorandum
      and Articles of Association.




Securities
Registers




Our
transfer agent and register is The Bank of New York and its address is 1 Wall
Street, New York, New York 10286.




Objects
and Purposes




According
to Section 4 of our Articles of Association the company shall engage in any
legal business.  Article 3 of our Articles of Association provides
that our purpose is to act pursuant to business consideration to make profit.
The company may contribute a reasonable amount for an appropriate object even if
the contribution is not within the said business considerations.




Private
Placements




Under
Blue Square’s Articles of Association, resolutions of the board of directors
regarding a private placement of Blue Square’s shares constituting, or
securities convertible into, more than ten percent of our outstanding share
capital require the approval of Blue Square’s shareholders. With respect to the
aforesaid, securities convertible or exercisable into shares are deemed to have
been converted or exercised on the date of their issue.


136


Under the
Israeli Companies Law, if (i) as a result of a private placement a person would
become a controlling shareholder or (ii) a private placement will entitle 20% or
more of the voting rights of a company before the placement, and all or part of
the private placement consideration is not in cash or in public traded
securities or is not in market terms and if as a result of the private placement
the holdings of substantial shareholder shall increase or as a result of it a
person shall become a substantial shareholder, then in either case, the
allotment must be approved by the board of directors and by the shareholders of
the company.  A “substantial shareholder” is defined as a shareholder
that holds five percent or more of the company’s outstanding share capital,
assuming the exercise of all of the securities convertible into shares held by
that person.  In order for the private placement to be in “market
terms” the board of directors has to determine, on the base of detailed
explanation, that the private placement is on market terms, unless proven
otherwise.




Board
of Directors




Under
Blue Square’s Articles of Association, resolutions by the board of directors
shall be decided by a majority of votes of the directors present (or
participating, in the case of voting by media) and voting, each director having
one vote.




In
addition, the Israeli Companies Law requires that certain transactions, actions
and arrangements be approved as provided for in a company’s articles of
association and in certain circumstances by the audit committee and by the board
of directors itself.  Those transactions that require such approval
pursuant to a company’s articles of association must be approved by its board of
directors.  In certain circumstances, audit committee and shareholder
approval is also required.  The vote required by the audit committee
and the board of directors for approval of such matters, in each case, is a
majority of the directors participating in a duly convened
meeting.  Under the Israeli Companies Law, the audit committee is to
be comprised of at least three members appointed by the board of directors,
which members must include all of the external directors, but excluding the
chairman of the board of directors, a controlling shareholder or his relative
and any director employed by the company or who provides services to the company
on a regular basis.




The
Israeli Companies Law requires that a member of the board of directors or senior
management of the company promptly disclose any personal interest that he or she
may have (either directly or by way of any corporation in which he or she 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) and all related material information
known to him or her, in connection with any existing or proposed transaction by
the company.  In addition, if the transaction is an extraordinary
transaction (that is, a transaction other than in the ordinary course of
business, otherwise than on market terms, or is likely to have a material impact
on the company’s profitability, assets or liabilities), the member of the board
of directors or senior management must also disclose any personal interest held
by his or her spouse, siblings, parents, grandparents, descendants,spouse’s
descendants and the spouses of any of the foregoing.


137


Once the
member of the board of directors or senior management complies with the above
disclosure requirement, a company may approve the transaction in accordance with
the provisions of its articles of association.  Further, under Blue
Square’s Articles of Association, subject to the provisions of the Companies
Law, (i) a transaction between us and an our officer or a person that controls
us or (ii) a transaction between us and another person in which an officer of
ours or a person that controls us has a personal interest, which transaction is
not in any such case extraordinary (Ordinary Interested Transactions), will be
approved by us in the following manner:




By the
board of directors, or by the audit committee, or by the Chief Executive Officer
with two directors that have no personal interest in the transaction, or by
another body authorized by the board of directors, whether such body is
authorized by the board of directors by means of a specific resolution or by
board practice, or whether such body is granted authority by means of a general
authorization, an authorization for a particular type of transaction or an
authorization for a particular transaction.




The
approval of Ordinary Interested Transactions by the bodies or persons may be
done by means of an approval of a particular type of transaction or an approval
of a particular transaction. The approval must confirm that the transaction is
not adverse to the company’s interest.  Furthermore, if the
transaction is an extraordinary transaction, then, in addition to any approval
stipulated by the Articles of Association, it also must be approved by the
company’s audit committee and then by the board of directors, and, under certain
circumstances, by a meeting of the shareholders of the company.  Under
the provisions of the Israeli Companies Law, 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, unless it is not an extraordinary transaction as defined in the Israeli
Companies Law. However, if the majority of the directors have a personal
interest in a matter, they shall be allowed to participate and vote on this
matter, but an approval of the transaction by the shareholders in the general
meeting shall be required.




Blue
Square’s Articles of Association provide that, subject to the Israeli Companies
Law, all actions executed in good faith by the board of directors or by a
committee thereof or by any person acting as a director or a member of a
committee of the board of directors will be deemed to be valid even if, after
their execution, it is discovered that there was a flaw in the appointment of
these persons or that any one of these persons was disqualified from serving at
his or her office.




The
Articles of Association provide that the board of directors may delegate all of
its powers to such committees of the board of directors as it deems appropriate,
subject to the provisions of the Israeli Companies Law, and they may from time
to time widen, narrow or cancel the delegation of such power.  The
Israeli Companies Law provides that certain powers of the board of directors may
not be delegated by the board of directors. See “Item 6. Directors, Senior
Management and Employees - C. Board Practices - Committees.”


138


According
to the Israeli Companies Law, a contract of a company with its directors,
regarding their conditions of service, including the grant to them of exemption
from liability from certain actions, insurance, and indemnification as well as
the company's contract with its directors on conditions of their employment, in
other capacities, require the approval of the audit committee, the board of
directors, and the shareholders.




Description
of Securities




Ordinary
Shares




The
following is a description of our ordinary shares.  Our authorized
share capital is 100,000,000 ordinary shares, par value NIS 1.0 per
share.




The
ordinary shares do not have preemptive rights, preferred rights or any other
right to purchase the company's security. Neither our Articles of Association
nor the laws of the State of Israel restrict the ownership or voting of ordinary
shares by non-residents of Israel, except for subjects of countries which are
enemies of Israel.




Transfer of
Shares.  Fully paid ordinary shares are issued in registered
form and may be freely transferred pursuant to our Articles of Association
unless that transfer is restricted or prohibited by another
instrument.




Notices.  Under the
Israeli Companies Law and our Articles of Association, we are required to
publish notices in two daily newspapers at least 14 calendar days’ prior notice
of an ordinary shareholders’ meeting and at least 21 calendar days’ prior notice
of any shareholders’ meeting in which the agenda includes matters which may be
voted on by voting instruments. Under regulations promulgated under the Israeli
Companies Law, however, we are required to publish notice in two daily
newspapers at least 35 calendar days prior any shareholders’ meeting in which
the agenda includes matters which may be voted on by voting instruments.
Regulations under the Israeli Companies Law exempt companies, like Blue Square,
whose shares are listed for trading both on a stock exchange in and outside of
Israel, from some provisions of the Israeli Companies Law. An amendment to these
regulations exempts us from the requirements of the Israeli proxy regulation,
under certain circumstances.




According
to the Israeli Companies Law and the regulations promulgated thereunder, for
purposes of determining the shareholders entitled to notice and to vote at such
meeting, the board of directors may fix the record date not more than 40 nor
less than four calendar days prior to the date of the meeting, provided that an
announcement regarding the general meeting shall be given prior to the record
date.




Election of
Directors.  Our ordinary shares do not have cumulative voting
rights in the election of directors.  As a result, the holders of
ordinary shares representing more than 50% of our ordinary shares and voting
power have the power to elect all of our directors, other than our external
directors, whose election requires, in addition to the vote of a majority of
shareholders, that at least one-third of the non-controlling shareholders who
participate in the vote, vote for their nomination, or that less than one
percent of the non-controlling shareholders vote against their
nomination.  Currently, Alon Retail has the power to elect all of our
directors other than our two external directors.  See Item
3.  Key Information - D. Risk Factors - “Alon Retail (formerly
Bronfman-Alon) is able to control the outcome of matters requiring shareholder
approval.”


139




Dividend and Liquidation
Rights.  Our profits, in respect of which a resolution was
passed to distribute them as dividend or bonus shares, shall be paid on account
of the nominal value of shares held by the shareholders. In the event of Blue
Square’s liquidation, the liquidator may, with the general meeting’s approval,
distribute parts of the company's property in specie among the shareholders and
he may, with similar approval, deposit any part of the company's property with
trustees in favor of the shareholders as the liquidate, with the approval
mentioned above deems fit.




Voting, Shareholders’ Meetings and
Resolutions.Holders of ordinary
shares are entitled to one vote for each ordinary share held on all matters
submitted to a vote of shareholders.  The quorum required for an
ordinary meeting of shareholders consists of at least two shareholders present,
in person or by proxy, or who has sent the company a voting instrument
indicating the way in which he is voting, who hold or represent, in the
aggregate, 50% or more of the voting rights of our outstanding share
capital.  A meeting adjourned for lack of a quorum is adjourned to the
same day in the following week at the same time and place or any time and place
as prescribed by the board of directors in notice to the shareholders. At the
reconvened meeting one shareholder at least, present in person or by proxy
constitute a quorum subject to the provisions of section 79 of the Israeli
Companies Law.




With the
agreement of a meeting at which a quorum is present, the chairman may, and on
the demand of the meeting he must, adjourn the meeting from time to time and
from place to place, as the meeting resolves.




Annual
general shareholders’ meetings of shareholders are held once every year within a
period of not more than 15 months after the last preceding annual general
shareholders’ meeting. The meeting shall be held at the companies registered
offices, unless the board of directors has determined otherwise. The board of
directors may call special general meetings of shareholders. The Israeli
Companies Law provides that a special general meeting of shareholders may be
called by the board of directors or by a request of two directors or 25% of the
directors in office, or by shareholders holding at least 5% of the issued share
capital of the company and at least 1% of the voting rights, or of shareholders
holding at least 5% of the voting rights of the company.




An
ordinary resolution requires approval by the holders of a majority of the voting
rights present, in person or by proxy, at the meeting and voting on the
resolution.




Modification of Class
Rights.Under Blue Square’s Articles of Association, unless
otherwise provided, the rights attached to any class, may be varied after a
resolution is passed by general meetings of the shareholders of each class of
shares separately or after obtaining the written consent of the holders of all
the classes of shares.


140


Allotment of
Shares.  Blue Square’s board of directors has the power to
allot or to issue shares to any person, with restrictions and condition, for
their nominal value or with a premium, as it deems fit.




Private
Placements




For
information on private placements, see “Item 10.  Additional
Information - B. Memorandum and Articles - Private Placements.”




C.
              Material
      Contracts.





Purchase
of Additional Shares in the Bee Group





On August
3, 2008, we entered into an agreement with the holders of 40% of the shares of
Bee Group (the "Sellers") to purchase an additional 9,354 ordinary shares and
650 preferred shares of Bee Group, increasing our holdings in Bee Group by 25%
to 85% of the shares of Bee Group, for consideration of NIS 35.4 million ($9.8
million at that time). The remaining 15% of the shares of Bee Group, which
consist of 5,996 shares (including 150 preferred shares) (the "Remaining
Shares"), were converted into ordinary shares of Bee Group on the transaction
closing date (the "Closing Date").  In addition under the agreement,
we have a call option to purchase the Remaining Shares from the Sellers during
the five-year period from the date of the Closing Date for consideration in the
amount of NIS 21.24 million plus 7.5% interest per year from  the
Closing Date and until the date on which the call option is exercised. In the
event that Bee Group distributes dividends with a record date prior to payment
for the exercise of the call option, the exercise price would be reduced by the
amount of the dividend in cash plus 7.5% interest per annum for the period from
the date of the dividend payment until exercise of the option. The Sellers have
a put option to sell their Remaining Shares to us beginning 24 months from the
closing date and for a period of 30 days at the same exercise price as the call
option.





The
Sellers have granted to us a fixed first lien on the Remaining Shares for the
period of the call option and up to 21 days after the expiration of the call
option.  The Remaining Shares will be held in escrow for this
period.  The Sellers have also given us an irrevocable power of
attorney giving us exclusive voting power over the Remaining Shares at Bee
Group's general meetings of shareholders.





In
addition, the sellers have agreed to non-compete provisions for periods between
two to four years.  Under the agreement, we agreed to continue to
provide officers and directors insurance to Bee Group's officers and directors
for a period of seven years from the Closing Date.





In the
event that an initial public offering is completed within 36 months from the
Closing Date, and Bee Group's shares are registered on the TASE (the "IPO"), we
must exercise the call option for the Remaining Shares within three days of
commencement of trading of Bee Group's shares on the TASE begins at an adjusted
exercise price. The adjusted exercise price of the Remaining Shares would be 15%
of the value attributed to Bee Group in the public offering reduced by (a)
expenses of the offering and by (b) investments in Bee Group's capital from the
Closing Date. In the event that the call or put options are exercised prior to
the initial public offering, the sellers would be entitled to the difference, if
any, between the adjusted exercise price described above and the exercise price
paid plus 7.5% interest per year on the exercise price paid commencing from the
date of payment of the exercise price.


141





For a
summary of other material contracts, see “Item 4. Information on The Company -
B. Business Overview General”, “Item 4. Information on The Company - B. Business
Overview - Related Businesses”, “Item 4. Information on The Company - B.
Business Overview – Our Yield Generating Real Estate, “Item
5.  Operating and Financial Review and Prospects - Liquidity and
Capital Resources - Debentures”, “Item 6.  Directors, Senior
Management and Employees - C. Board Practices - Exemption, Insurance and
Indemnification of Directors and Officers - Limitations on Insurance, Exemptions
and Indemnification”, “Item 6.  Directors, Senior Management and
Employees - D. Employees”, “Item 7.  Major Shareholders and Related
Party Transactions - B. Related Party Transactions,” and our consolidated
financial statements and notes included elsewhere in this Annual
Report.





D.
            Exchange
      Controls.





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




Dividends,
if any, paid to 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 our ordinary shares to an Israeli resident, may be paid in non-Israeli
currency or, if paid in Israeli currency, may be converted into freely
repatriable dollars at the rate of exchange prevailing at the time of
conversion.




E.
            Taxation




Israeli
Tax Considerations




General





The
following is a summary of the current tax laws of the State of Israel as they
relate to us and to our shareholders. Also included is a discussion of the
material Israeli tax consequences to for persons purchasing our ordinary shares
or ADSs (the "Shares").


142


This
discussion does not purport to be a complete analysis of all potential tax
consequences of owning the Shares. In particular, this discussion does not take
into account the specific circumstances of any particular investor (such as
tax-exempt entities, banks, certain financial companies, broker-dealers,
investors that own, directly or indirectly, 10% or more of our outstanding
voting rights, or foreign companies, if Israeli residents hold 25% or more of
their shares or have the right to 25% or more of their income or profit, all of
whom are subject to special tax regimes not covered in this discussion). The
discussion is based on legislation yet to be subject to judicial or
administrative interpretation, and there can be no assurance that the views
expressed herein will accord with any such interpretation in the future. This
discussion is not intended and should not be construed as legal or professional
tax advice and does not cover all possible tax considerations.




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




Israeli Tax Reform





On July
24, 2002, the Israeli Parliament enacted income tax reform legislation (2003 Tax Reform). The Tax
Reform introduced fundamental and comprehensive changes to Israeli tax laws.
Most of the legislative changes took effect on January 1, 2003. The Tax Reform
introduced a transition from a primarily territorial-based tax system to a
personal-based system of taxation with respect to Israeli residents, and
resulted in significant amendment of the international taxation provisions, and
in new provisions concerning the taxation of capital markets including the
abolishment of formerly "exempt investment routes" (e.g., capital gains
generated by individuals from the sale of securities traded on the Tel-Aviv
Stock Exchange).




It should
be noted that under the 2003 Tax Reform legislation, the Shares are no longer
regarded and defined as “foreign traded securities” and thus certain associated
Israeli tax aspects will accordingly be subject to change as discussed
below.




A
relatively short time after the 2003 Tax Reform, the Israeli Parliament approved
on July 25, 2005 an additional income tax reform legislation (2006 Tax Reform) pursuant to
the recommendations of a committee appointed by the Israeli Minister of Finance,
which incorporated additional fundamental changes to Israeli tax law. The 2006
Tax Reform, inter alia, includes a gradual reduction of income tax rates for
both individuals and corporations through 2010, and outlines a path towards
uniformity in the taxation of interest, dividend and capital gains derived from
securities. Most of the amendments to the tax law are effective as of January 1,
2006, subject to certain exceptions. Transition rules apply in certain
circumstances.




It should
be noted that various issues related to the 2003 Tax Reform and 2006 Tax Reform
remain unclear in view of the legislative language utilized. The analysis below
is therefore based on our current understanding of the new
legislation.


143


General Corporate Tax Structure in
Israel





The
corporate tax rate applicable in 2008 was 27%. This rate was reduced to 26% in
2009 and had been scheduled to be reduced to 25% in 2010 and
beyond.




Dividends
received by an Israeli corporation from Israeli subsidiaries are, generally,
exempt from corporate tax.




TAXATION
OF SHAREHOLDERS





Capital
Gains





Capital gain tax is imposed on the
disposal of capital assets by an Israeli resident, and on the disposal of such
assets by a non-Israeli resident if those assets are either (i) located in
Israel; (ii) are shares or a right to a share in an Israeli resident
corporation, or (iii) represent, directly or indirectly, rights to assets
located in Israel. The Israeli Tax Ordinance distinguishes between "Real Gain"
and the "Inflationary Surplus". Real Gain is the excess of the total capital
gain over Inflationary Surplus computed generally on the basis of the increase
in the Israeli CPI between the date of purchase and the date of
disposal.





The capital gain accrued by individuals
on the sale of an asset purchased on or after January 1, 2003 will be taxed at
the rate of 20%. However, if the individual shareholder is a "Controlling
Shareholder” (i.e., a  person who holds, directly or indirectly, alone
or together with another, 10% or more of one of the Israeli resident company's
means of control at the time of sale or at any time during the preceding 12
month period), such gain will be taxed at the rate of 25%. In addition, capital
gain derived by an individual claiming deduction of financing expenses in
respect of such gain will be taxed at the rate of 25%.





The real capital gain derived by a
corporation generally will be subject to tax at the rate of 25%. However, if
such real capital gain were derived from the sale of securities (as defined in
Section 6 of the Inflationary Adjustment Law) by a corporation that had been
subject on August 10, 2005 to the provisions of Section 6 of the Inflationary
Adjustment Law, such real capital gain will be taxed at the corporate tax rate
(27% in 2008 and 26% in 2009). The capital gain accrued on the sale of an asset
purchased prior to January 1, 2003 will be subject to tax at a blended
rate.  The marginal tax rate for individuals (up to 47% in 2008 and
46% in 2009) and the regular corporate tax rate for corporations (27% in 2008
and 26% in 2009) will be applied to the portion of the gain amount which bears
the same ratio to the total gain realized as the ratio which the holding period
commencing at the acquisition date and terminating on January 1, 2003 bears to
the total holding period.  The remainder of the gain realized will be
subject to capital gains tax at the rates applicable to an asset purchased after
January 1, 2003.


144


Individual and corporate shareholders
dealing in securities in Israel are taxed at the tax rates applicable to
business income (27% in 2008 and 26% in 2009 tax rate for corporations and a
marginal tax rate of up to 47% in 2008 and 46% in 2009 for individuals).
Notwithstanding the foregoing, if the shareholder is a non-Israeli resident,
then such taxation is subject to the provisions of any applicable double tax
treaty. Moreover, capital gain derived from the sale of the Shares by a
non-Israeli shareholder may be exempt under the Israeli income tax ordinance
from Israeli taxation provided the following cumulative conditions are met: (i)
the Shares were purchased upon or after the registration of the Shares on the
stock exchange (ii) the seller does not have a permanent establishment in Israel
to which the derived capital gain is attributed, and (iii) if the seller is a
corporation, less than 25% of its means of control are held by Israeli resident
shareholders. In addition, the sale of the Shares may be exempt from Israeli
capital gain tax under an applicable tax treaty.  Thus, the
U.S.-Israel Double Tax Treaty exempts a U.S. resident from Israeli capital gain
tax in connection with the sale of  the Shares, provided (i) the U.S.
resident owned, directly or indirectly, less than 10% of an Israeli resident
company's voting power at any time within the 12 month period preceding such
sale; (ii) the U.S. resident, being an individual, is present in Israel for a
period or periods of less than 183 days during the taxable year; and (iii) the
capital gain from the sale was not derived through a permanent establishment of
the U.S. resident in Israel.





Either the seller, the Israeli
stockbrokers or financial institution through which the Shares are held are
obligated, subject to the above mentioned exemptions, to withhold tax upon the
sale of Shares from the real capital gain at the rate of 25% in respect of a
corporation and 20% in respect of an individual.





Upon the sale of traded securities, a
detailed return, including a computation of the tax due, should be filed and an
advanced payment should be paid to the ITA  on January 31 and June 30
of every tax year in respect of sales of securities made within the previous six
months. However, if all tax due was withheld at source according to applicable
provisions of the Israeli Income Tax Ordinance and regulations promulgated
thereunder, such return should not be filed and no advance payment should be
paid. Capital gain is also reportable on the annual income tax
return.





Dividends





A dividend distributed by our Company
to an Israeli resident who is an individual, generally will be subject to income
tax at a rate of 20%. However, a 25% tax rate will apply if the dividend
recipient is a “Controlling Shareholder” (i.e., a person who holds, directly or
indirectly, alone or together with other, 10% or more of one of the Israeli
resident company's means of control at the time of distribution or at any time
during the preceding 12 month period). If the recipient of the dividend is an
Israeli resident corporation, such dividend will be exempt from income tax,
provided that the income from which such dividend is distributed was derived or
accrued within Israel.





A dividend distributed by us to a
non-Israeli resident (either individual or corporation) is generally subject to
Israeli income tax on the receipt of dividends at the rate of 20% (25% if the
dividends recipient is a “Controlling Shareholder” (as defined above)); such
rates are subject to a reduced tax rate under an applicable double tax treaty
(if the tax rate under such double tax treaty exceeds the rate prescribed under
the Israeli Income Tax Ordinance, then the rate under the Israeli Income Tax
ordinance shall prevail). Thus, under the Double Tax Treaty between the State of
Israel and the U.S., a tax at the rate of 25% generally applies in respect of
dividends distributed by us to a U.S. resident.  However, if the U.S.
resident is a corporation which holds during that portion of the taxable year
which precedes the date of payment of the dividend and during the whole of its
prior taxable year (if any), at least 10% of our Company's voting shares and not
more than 25% of the gross income of our Company for such prior taxable year (if
any) consists of certain types of interest or dividends, then the tax rate will
be 12.5%. The aforementioned rates under the Double Tax Treaty between the State
of Israel and the U.S. will not apply if the dividend income was derived through
a permanent establishment of the U.S. resident in Israel.


145





Our Company is obligated to withhold
tax upon the distribution of a dividend at the following withholding tax rates:
(i) Israeli resident corporation – 0%, (ii) Israeli resident individual – 20%
and (iii) non-Israeli resident – 20%, subject to a reduced tax rate under an
applicable double tax treaty.





Estate
and Gift Tax




Israeli law presently does not impose
estate or gift tax.




United
States Federal Income Tax Considerations




The
following is a summary of the material U.S. federal income tax consequences that
apply to U.S. Holders who hold Blue Square’s ADSs or ordinary shares (together
“Shares”) as capital assets for tax purposes.  This summary is based
on current provisions of the Internal Revenue Code of 1986, as amended, current
and proposed Treasury regulations promulgated thereunder, and administrative and
judicial decisions as of the date hereof, all of which are subject to change,
possibly on a retroactive basis.  This summary does not address all
U.S. federal income tax matters that may be relevant to a particular perspective
holder or all tax considerations that may be relevant with respect to an
investment in Blue Square’s Shares.




This
summary does not address tax considerations applicable to a holder of a Blue
Square Shares that may be subject to special tax rules including, without
limitation, the following:




·           dealers
or traders in securities, currencies or notional principal
contracts;


·           financial
institutions;


·           insurance
companies;


·           real
estate investment trusts;


·           banks;


·           investors
subject to the alternative minimum tax;


·           tax-exempt
organizations;


·           traders
that have elected mark-to-market accounting;


·           investors
that hold Shares as part of a “straddle”, “hedge”, or “conversion transaction”
with other investments;


·           regulated
investment companies;


·           investors
that actually or constructively own 10 percent or more of our voting
shares;


146





·           investors
that are treated as partnerships or other pass through entities for U.S. federal
income purposes and persons who hold the Shares through partnerships or other
pass through entities; and


·           investors
whose functional currency is not the U.S. dollar.


This
summary does not address the effect of any U.S. federal taxation other than U.S.
federal income taxation.  In addition, this summary does not include
any discussion of state, local, or foreign taxation or the indirect effects on
the holders of equity interest in a holder of the Shares.




You
are urged to consult your own tax advisor regarding the foreign and U.S.
federal, state, and local and other tax consequences of an investment in the
Shares.




For
purposes of this summary, a “U.S. Holder” means a beneficial owner of a Share
that is for U.S. federal income tax purposes:




·
            an
      individual who is a citizen or resident of the United
    States;




·
            a
      corporation (or other entity taxable as a corporation for U.S. federal
      income tax purposes) created or organized in the United States or under
      the laws of the United States or any political subdivision
      thereof;




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




·
            a
      trust (1) if (a) a court within the United States is able to exercise
      primary supervision over the administration of the trust; and (b) one or
      more U.S. persons have the authority to control all substantial decisions
      of the trust; or (2) that has a valid election in effect under applicable
      U.S. Treasury regulations to be treated as a U.S.
  person.




If an
entity that is classified as a partnership for U.S. federal tax purposes holds
Shares, the U.S. federal tax treatment of its partners will generally depend
upon the status of the partners and the activities of the
partnership.  Entities that are classified as partnerships for U.S.
federal tax purposes and persons holding Shares through such entities should
consult their own tax advisors.




In
addition, certain material aspects of United States federal income tax relevant
to a holder other than a U.S. Holder, referred to as a “non-U.S. Holder,” are
discussed below.  For purposes of this section, a “non-U.S. Holder” is
any holder who is not a U.S. Holder.




In
general, if you hold ADSs, you will be treated as the holder of the underlying
shares represented by those ADSs for U.S. federal income tax
purposes.  Accordingly, no gain or loss will be recognized if you
exchange ADSs for the underlying shares represented by those
ADSs.


147


The U.S.
Treasury has expressed concerns that parties to whom Shares are released may be
taking actions that are inconsistent with the claiming of foreign tax credits
for U.S. holders of Shares.  Such actions would also be inconsistent
with the claiming of the reduced rate of tax, described below, applicable to
dividends received by certain non-corporate U.S.
Holders.  Accordingly, the analysis of the credibility of Israeli
taxes and the availability of the reduced tax rate for dividends received by
certain non-corporate U.S. Holders, each described below, could be affected by
actions taken by parties to whom the Shares are released.




U.S
Taxation of Shares




Distributions




Subject
to the discussion under “Passive Foreign Investment Companies” below, the gross
amount of any distribution, including the amount of any Israeli taxes withheld
from these distributions (see “Israeli Tax Considerations”), actually or
constructively received by a U.S. Holder with respect to Shares will be taxable
to the U.S. Holder as a dividend to the extent of our current and accumulated
earnings and profits as determined under U.S. federal income tax
principles.  The U.S. Holder will not, except as provided by Section
245 of the Internal Revenue Code of 1986, as amended (the “Code”), be eligible
for any dividends received deduction in respect of the dividend otherwise
allowable to corporations.  Distributions in excess of earnings and
profits will be non-taxable to the U.S. Holder to the extent of, and will be
applied against and reduce, the U.S. Holder’s adjusted tax basis in the
Shares.  Distributions in excess of such adjusted tax basis will
generally be taxable to the U.S. Holder as capital gain from the sale or
exchange of property.  If we do not report to a U.S. Holder the
portion of a distribution that exceeds earnings and profits, the distribution
will generally be taxable as a dividend even if that distribution would
otherwise be treated as a non-taxable return of capital or as capital gain under
the rules described above.  The amount of any distribution of property
other than cash will be the fair market value of that property on the date of
distribution.




Under the
Code, certain dividends received by non-corporate U.S. Holders with respect to
taxable years beginning on or before December 31, 2010, will be subject to a
maximum income tax rate of 15%.  This reduced income tax rate is only
applicable to dividends paid by a “qualified foreign corporation” that is not a
“passive foreign investment company” and only with respect to shares held by a
qualified U.S. Holder (i.e., a non-corporate holder) for a minimum holding
period (generally 61 days during the 121-day period beginning 60 days before the
ex-dividend date).  We should be considered a qualified foreign
corporation because (i) we are eligible for the benefits of a comprehensive tax
treaty between Israel and the U.S., which includes an exchange of information
program, and (ii) the ADSs are readily tradeable on an established securities
market in the U.S.  In addition, based on our current business plans,
we do not expect to be classified as a “passive foreign investment company” (see
“Passive Foreign Investment Companies” below).  Accordingly, dividends
paid by us to individual U.S. Holders on shares held for the minimum holding
period should be eligible for the reduced income tax rate.  The
reduced tax rate for qualified dividends is scheduled to expire on December 31,
2010, unless further extended by Congress.


148


The
amount of any distribution paid in a currency other than U.S. dollars (a
“foreign currency”) including the amount of any withholding tax thereon, will be
included in the gross income of a U.S. Holder in an amount equal to the U.S.
dollar value of the foreign currency calculated by reference to the exchange
rate in effect on the date of the U.S. Holder’s (or, in the case of ADSs, the
depositary’s) receipt of the dividend, regardless of whether the foreign
currency is converted into U.S. dollars.  If the foreign currency is
converted into U.S. dollars on the date of receipt, a U.S. Holder generally
should not be required to recognize foreign currency gain or loss in respect of
the dividend.  If the foreign currency received in the distribution is
not converted into U.S. dollars on the date of receipt, a U.S. Holder will have
a basis in the foreign currency equal to its U.S. dollar value on the date of
receipt.  Any gain or loss on a subsequent conversion or other
disposition of the foreign currency will be treated as ordinary income or
loss.




Dividends
received by a U.S. Holder with respect to Shares will be treated as foreign
source income for the purposes of calculating the holder’s foreign tax credit
limitation.  Subject to certain conditions and limitations, any
Israeli taxes withheld on dividends at the rate provided by the U.S.-Israel
income tax treaty may be deducted from taxable income or credited against a U.S.
Holder’s U.S. federal income tax liability.  The limitation on foreign
taxes eligible for the U.S. foreign tax credit is calculated separately with
respect to “passive” income and “general” income.  The rules relating
to foreign tax credits and the timing thereof are complex.  U.S.
Holders should consult their own tax advisors regarding the availability of a
foreign tax credit under their particular situation (including, in the case of a
U.S. corporation that owns 10 percent or more of our voting stock, the possible
application of Section 902 of the Code).




Sale
or Other Disposition of Shares




If a U.S.
holder sells or otherwise disposes of its Shares, gain or loss will be
recognized for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized on the sale or other disposition and such
holder’s adjusted basis in the Shares.  Subject to the discussion
below under the heading “Passive Foreign Investment Companies,” such gain or
loss generally will be capital gain or loss and will be long-term capital gain
or loss if the holder had held the Shares for more than one year at the time of
the sale or other disposition.  Long-term capital gains realized by
individual U.S. Holders generally are subject to a lower marginal U.S. federal
income tax rate (currently 15%) than ordinary income.  Under most
circumstances, any gain that a holder recognizes on the sale or other
disposition of Shares will be U.S. source for purposes of the foreign tax credit
limitation and any recognized losses will be allocated against U.S. source
income.




If a U.S.
Holder receives foreign currency upon a sale or exchange of Shares, gain or loss
will be recognized as described above and in addition, gain or loss, if any,
recognized on the subsequent sale, conversion, or disposition of such foreign
currency will be ordinary income or loss, and will generally be income or loss
from sources within the United States for foreign tax credit limitation
purposes.  However, if such foreign currency is converted into U.S.
dollars on the date received by the U.S. Holder, the U.S. Holder generally
should not be required to recognize any gain or loss on such
conversion.


149


A U.S.
Holder who holds Shares through an Israeli stockbroker or other Israeli
intermediary may be subject to an Israeli withholding tax on any capital gains
recognized if the U.S. Holder does not obtain approval of an exemption from the
Israeli Tax Authorities. U.S. Holders are advised that any Israeli tax paid
under circumstances in which an exemption from such tax was available will not
give rise to a deduction or credit for foreign taxes paid for U.S. federal
income tax purposes. U.S. Holders are advised to consult their Israeli
stockbroker or intermediary regarding the procedures for obtaining an
exemption.




Passive
Foreign Investment Companies




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




If we are
treated as a PFIC for any taxable year,




·           a
U.S. Holder would be required to allocate income recognized upon receiving
certain dividends or gain recognized upon the disposition of Shares ratably over
its holding period for such Shares,




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




·           the
amount allocated to the year of the dividend payment or disposition would be
taxable as ordinary income, and




·           a
U.S. Holder would be required to make an annual return on IRS Form 8621
regarding distributions received and gain realized with respect to
Shares.




One
method to avoid the aforementioned treatment is for a U.S. Holder to make an
election to treat us as a qualified electing fund.  A U.S. Holder that
makes an election to treat us as a qualified electing fund (an “electing U.S.
Holder”) is required for each taxable year to include in income a pro rata share
of the ordinary earnings of the qualified electing fund as ordinary income and a
pro rata share of the net capital gain of the qualified electing fund as
long-term capital gain, subject to a separate election to defer payment of
taxes, which deferral is subject to an interest charge.  A U.S. Holder
may make a qualified electing fund election only if we furnish the U.S. Holder
with certain tax information.  We have agreed to supply an electing
U.S. Holder with such information needed to report income and gain pursuant to a
qualified election in the event Blue Square is classified as a
PFIC.  Alternatively, another method to avoid the aforementioned
treatment is for a U.S. Holder to make a timely mark-to-market election in
respect of its Shares.  If a U.S. Holder elects to mark-to-market its
Shares, any excess of the fair market value of the Shares at the close of each
tax year over the adjusted basis in such Shares will generally be included in
income.  If the fair market value of the Shares had depreciated below
the adjusted basis at the close of the tax year, the U.S. Holder may generally
deduct the excess of the adjusted basis of the Shares over their fair market
value at that time.  However, such deductions generally would be
limited to the net mark-to-market gains, if any, that were included in income by
such holder with respect to Shares in prior years.  Income recognized
and deductions allowed under the mark-to-market provisions, as well as any gain
or loss on the disposition of Shares with respect to which the mark-to-market
election is made, is treated as ordinary income or loss.


150




Based on
our estimated gross income, the average value of our gross assets, and the
nature of our business, we do not believe that we will be classified as a PFIC
in the current taxable year.  Our status in any taxable year will
depend on our assets and activities in each year and because this is a factual
determination made annually at the end of each taxable year, there can be no
assurance that we will not be considered a PFIC for any future taxable
year.  If we determine that we have become a PFIC, we will notify our
U.S. Holders and provide them with the information necessary to comply with the
qualified electing fund rules.  If we are treated as a PFIC in any
year during which a U.S. Holder owns Shares, certain adverse tax consequences
could apply, as described above.  Given our current business plans,
however, we do not expect that we will be classified as a PFIC in future
years.




You
are urged to consult your own tax advisor regarding the possibility of us being
classified as a PFIC and the potential tax consequences arising from the
ownership and disposition (directly or indirectly) of an interest in a
PFIC.




Backup
Withholding and Information Reporting




Payments
of dividends with respect to Shares and the proceeds from the sale, retirement,
or other disposition of Shares made by a U.S. paying agent or other U.S.
intermediary will be reported to the IRS and to the U.S. Holder as may be
required under applicable U.S. Treasury regulations.  We, or an agent,
a broker, or any paying agent, as the case may be, may be required to withhold
tax, currently at the rate of 28% (the backup withholding tax), if a
non-corporate U.S. Holder that is not otherwise exempt fails to provide an
accurate taxpayer identification number and comply with other IRS requirements
concerning information reporting.  Certain U.S. Holders (including,
among others, corporations and tax-exempt organizations) are not subject to
backup withholding.  Backup withholding is not an additional
tax.  Any amount of backup withholding withheld may be used as a
credit against your U.S. federal income tax liability provided that the required
information is furnished to the IRS.  U.S. Holders should consult
their tax advisors as to their qualification for exemption from backup
withholding and the procedure for obtaining an exemption.




U.S.
Federal Income Tax Consequences to Non-U.S. Holders




Sale,
Exchange or Retirement of Shares




A
non-U.S. Holder generally will not be subject to U.S. federal income tax or any
withholding thereof with respect to gain realized on a sale or other disposition
of our Shares unless one of the following applies:


151




·           the
gain is effectively connected with the non-U.S. Holder’s conduct of a trade or
business in the United States and, in the case of a resident in a country which
has a treaty with the United States, such gain is attributable to a permanent
establishment or, in the case of an individual, a fixed place of business in the
United States;




·           the
non-U.S. Holder is an individual who holds Shares as a capital asset and is
present in the United States for 183 days or more in the taxable year of the
disposition and meets certain other requirements; or




·           the
non-U.S. Holder is subject to tax pursuant to the provisions of United States
tax law applicable to U.S. expatriates.




Backup
Withholding and Information Reporting




Non-U.S.
Holders generally are not subject to information reporting or backup withholding
with respect to dividends paid on, or upon the disposition of Shares, provided
that the non-U.S. Holder provides a taxpayer identification number, certifies to
its foreign status, or otherwise establishes an exemption.




The
amount of any backup withholding will be allowed as a credit against a non-U.S.
Holder’s United States federal income tax liability and may entitle such holder
to a refund, provided that certain required information is furnished to the
IRS.




Non-U.S.
Holders are urged to consult legal and tax advisors in the countries of their
citizenship, residence and domicile to determine the possible tax consequences
of holding and selling Shares under the laws of their respective jurisdictions
in light of their own particular circumstances.




F.
            Dividends
      and Paying Agents.




Not
applicable.




G.
            Statement
      by Experts.




Not
applicable.




H.
            Documents
      on Display.




Blue
Square is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended, applicable to foreign private issuers and fulfills the
obligation with respect to these requirements by filing reports with the
Securities and Exchange Commission (SEC).  You may read and copy any
document Blue Square files with the SEC without charge at the SEC’s public
reference room at 450 Fifth Street, N.W., Washington, D.C.
20549.  Copies of that material may be obtained by mail from the
Public Reference Branch of the SEC at such address, at prescribed
rates.  Please call the SEC at l-800-SEC-0330 for further information
on the public reference room.  Recent reports filed by Blue Square
with the SEC can also be accessed at the SEC’s web site,
www.sec.gov.


152




As a
foreign private issuer, Blue Square is exempt from the rules under the Exchange
Act prescribing the furnishing and content of proxy statements, and its
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, Blue Square is 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 Blue Square’s principal executive
offices.




I.
            Subsidiary
      Information.




Not
applicable.




ITEM
      11.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




Interest Rate
Sensitivity




The
Company is exposed to various market risks, most of them related to changes in
interest rates and changes in the Israeli CPI.  Loans and
Debentures in the amount of approximately NIS 1,599 million and marketable
securities in the amount of approximately NIS 172 million bear interest at fixed
rates, and therefore changes in the interest rates will affect the fair value of
such loans and marketable securities. Other loans set forth below bear interest
at variable rates (as a result of changing interest rates or CPI linkage), and
therefore change in the CPI or the prime interest rate will affect future cash
flow and interest expenses.




The table
below provides information about Blue Square’s financial instruments as of
December 31, 2008:


153




December 31, 2008Expected Maturity (NIS in thousands) (2)2009
                        
                        
                        2010
                        
                        
                        2011
                        
                        
                        2012
                        
                        
                        2013
                        
                        
                        from 2014
                          and thereafter
                        
                        
                        TotalLong
      term loan from banks - linked:Linked
      to the Israeli CPI - 5.1% (weighted average rate as of December 31,
      2008)
                        
                        
                        46,394
                        
                        
                        
                        19,454
                        
                        
                        
                        10,763
                        
                        
                        
                        8,964
                        
                        
                        
                        5,660
                        
                        
                        
                        22,645
                        
                        
                        
                        113,880Long
      term loans from bank - unlinked:Fixed
      annual interest rate of 5.5%
                        
                        
                        64,667
                        
                        
                        
                        62,434
                        
                        
                        
                        58,173
                        
                        
                        
                        49,256
                        
                        
                        
                        38,047
                        
                        
                        
                        32,879
                        
                        
                        
                        305,456Variable
      interest (average annual rate as of December 31, 2008
4.6%)
                        
                        
                        21,852
                        
                        
                        
                        15,944
                        
                        
                        
                        10,855
                        
                        
                        
                        3,075
                        
                        
                        
                        512
                        
                        
                        
                        2,925
                        
                        
                        
                        55,163132,913
                        
                        
                        
                        97,832
                        
                        
                        
                        79,791
                        
                        
                        
                        61,295
                        
                        
                        
                        44,219
                        
                        
                        
                        58,449
                        
                        
                        
                        474,499Debentures
      - Linked to the Israeli CPI:Issued by the Company
      - fixed rate 5.9% (1)
                        
                        
                        
                        
                        
                        
                        73,089
                        
                        
                        
                        
                        
                        
                        
                        48,725
                        
                        
                        
                        48,726
                        
                        
                        
                        48,726
                        
                        
                        
                        219,266Issued
      by BSRE - fixed rate 4.7%
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        204,570
                        
                        
                        
                        613,710
                        
                        
                        
                        818,280Convertible
      Debentures Linked to the Israeli  CPI:Issued by the Company
      - fixed rate 5.9% (1)
                        
                        
                        18,311
                        
                        
                        
                        
                        
                        
                        
                        18,311
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        36,622Issued
      by BSRE - fixed rate 6.25%
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        26,396
                        
                        
                        
                        79,189
                        
                        
                        
                        105,58518,311
                        
                        
                        
                        73,089
                        
                        
                        
                        18,311
                        
                        
                        
                        48,725
                        
                        
                        
                        279,692
                        
                        
                        
                        741,625
                        
                        
                        
                        1,179,753Marketable
      Securities - Linked to the Israeli CPI:
                        
                        
                        104,803
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        104,803Marketable
      Securities – unlinked in NIS
                        
                        
                        61,485
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        61,485Marketable
      Securities –in other currencies
                        
                        
                        5,561
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        5,561




(1)
            See
      also “Item 5. Operating and Financial Review and Prospects - Liquidity and
      Capital Resources - Debentures”.




(2)
            Does
      not include forward contracts over the Israeli CPI in the amount of
      approximately NIS 11.6 million.  The principal amount of the
      outstanding forward contracts at December 31, 2008 was NIS 351
      million.




For
CPI-linked financial instruments as stipulated in the table above, a one
percent increase (decrease) in the CPI would cause an approximately NIS 9
million decrease (increase) in net income for the next year.




Inflation
Risks





The
Company has an excess of Israeli CPI-linked liabilities over Israeli CPI-linked
assets (mainly in respect of outstanding debentures). As a result, an increase
in inflation would have the effect of increasing our financial expenses without
any offsetting increase in our assets and revenues on our financial statements,
leading to lower reported earnings and shareholders equity. The extent of this
effect on our financial statement would be dependent on the rate of inflation in
Israel.


154




The table
below provides information about the changes of the CPI and the “known" CPI
index:




CPI
                  
                  
                  The “known" CPI index2006
                  
                  
                  (0.1
                  )%
                  
                  
                  (0.3
                  )%2007
                  
                  
                  3.4
                  %
                  
                  
                  2.8
                  %2008
                  
                  
                  3.8
                  %
                  
                  
                  4.51
                  %




The table
below provides an analysis of monetary assets and liabilities by currency and
linkage as of December 31, 2008:




December 31, 2008NIS linked
                    to CPI
                
                
                NIS
                    unlinked
                
                
                US
                    Dollar
                
                
                Other
                    currenciesNIS in thousandsAssets:Cash
      and cash equivalents
                
                
                -
                
                
                
                95,325
                
                
                
                -
                
                
                
                -Short
      term bank deposits
                
                
                -
                
                
                
                206
                
                
                
                -
                
                
                
                -Marketable
      securities
                
                
                104,803
                
                
                
                61,485
                
                
                
                4,653
                
                
                
                908Trade
      receivables
                
                
                -
                
                
                
                729,970
                
                
                
                -
                
                
                
                -Other
      receivables
                
                
                -
                
                
                
                69,926
                
                
                
                -
                
                
                
                -Income
      taxes receivable
                
                
                74,446
                
                
                
                -
                
                
                
                -
                
                
                
                -Derivative
      financial instrument
                
                
                -
                
                
                
                4,700
                
                
                
                548
                
                
                
                -Long-term
      receivables
                
                
                3,268
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
      assets
                
                
                182,517
                
                
                
                961,612
                
                
                
                5,201
                
                
                
                908Liabilities:Short-term
      bank credit and loans
                
                
                -
                
                
                
                77,988
                
                
                
                -
                
                
                
                -Trade
      payables
                
                
                -
                
                
                
                1,006,053
                
                
                
                333
                
                
                
                -Other
      accounts payable andaccrued
      expenses
                
                
                34,437
                
                
                
                446,770
                
                
                
                -
                
                
                
                -Income
      tax payables
                
                
                6,933
                
                
                
                -
                
                
                
                -
                
                
                
                -Loans
                
                
                113,880
                
                
                
                360,619
                
                
                
                -
                
                
                
                -Debentures
                
                
                985,844
                
                
                
                -
                
                
                
                -
                
                
                
                -Convertible
      debentures
                
                
                156,524
                
                
                
                -
                
                
                
                -
                
                
                
                -Long-term
      payable
                
                
                2,984
                
                
                
                30,633
                
                
                
                4,753
                
                
                
                -Derivative
      financial instruments
                
                
                942
                
                
                
                -
                
                
                
                1,238
                
                
                
                7,301Total
      liabilities
                
                
                1,301,544
                
                
                
                1,922,063
                
                
                
                6,324
                
                
                
                7,301




For
further information regarding market risks, see note 3 to our consolidated
financial statements.


155




ITEM
      12.
              DESCRIPTION
      OF SECURITIES OTHER THAN EQUITY
SECURITIES




Not
applicable.




PART
II




ITEM
      13.
              DEFAULTS,
      DIVIDEND ARREARAGES AND
DELINQUENCIES




Not
applicable.




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




A. to
E.Not applicable.




ITEM
      15.
            CONTROLS
      AND PROCEDURES




(a) Disclosure Controls and
Procedures. We performed an evaluation of the effectiveness of our
disclosure controls and procedures that are designed to ensure that the material
financial and non-financial information required to be disclosed on Form 20-F
and filed with the Securities and Exchange Commission is recorded, processed,
summarized and reported timely within the time period specified in the SEC’s
rules and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by an issuer in the reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is accumulated and communicated to
the issuer’s management, including its principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. There can be no assurance
that our disclosure controls and procedures will detect or uncover all failures
of persons within Blue Square to disclose material information otherwise
required to be set forth in our reports. Nevertheless, our disclosure controls
and procedures are designed to provide reasonable assurance of achieving the
desired control objectives. Based on our evaluation, our management, including
our Chief Executive Officer and Chief Financial Officer, have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d) -
15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the
period covered by this report are effective at such reasonable assurance
level.




(b) Management’s Annual Report
on Internal Control over Financial Reporting. Our management, under the
supervision of our Chief Executive Officer and Chief Financial Officer, is
responsible for establishing and maintaining adequate internal control over our
financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange
Act of 1934, as amended. The Company’s internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Internal
control over financial reporting includes policies and procedures
that:


156




·
            pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect our transactions and asset
  dispositions;




·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      the preparation of our financial statements in accordance with generally
      accepted accounting principles;




·
            provide
      reasonable assurance that receipts and expenditures are made only in
      accordance with authorizations of our management and board of directors
      (as appropriate); and




·
            provide
      reasonable assurance regarding the prevention or timely detection of
      unauthorized acquisition, use or disposition of assets that could have a
      material effect on our financial
statements.




Due to
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. In addition, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we assessed the effectiveness of
our internal control over financial reporting as of December 31, 2008 based
onthe framework for
Internal Control-Integrated Framework set forth by The Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Based on our assessment and
this framework, our management concluded that the Company's internal control
over financial reporting were effective as of December 31,
2008.




(c) 
The effectiveness of the Company’s internal control over financial reporting as
of December 31, 2008 has been audited by Kesselman & Kesselman an
independent registered public accounting firm in Israel and a member of
PricewaterhouseCoopers International Limited, which has audited the financial
statements included in this Annual Report on Form 20-F; their report is included
in Item 17.




(d)  Changes in internal control
over financial reporting. There were no changes in our internal control
over financial reporting that occurred during the year ended December 31, 2008
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.


157


ITEM
      16.
            [RESERVED]




ITEM
      16A.
            AUDIT
      COMMITTEE FINANCIAL EXPERT




The board
of directors has determined that Avraham Meiron is an "audit committee financial
expert" as defined in Item 16A of Form 20-F and is independent in accordance
with the NYSE listing standards for audit committees applicable to Blue
Square.




ITEM
      16B.
            CODE
      OF ETHICS




As of the
date of this Annual Report, we have adopted a code of ethics that applies to our
Chief Executive Officer, President, Chief Financial Officer, Corporate
Controller and employees. This code of ethics is posted on our website, www.bsi.co.il/codeofethics.htm
..




ITEM
      16C.
            PRINCIPAL
      ACCOUNTANT FEES AND SERVICES




Kesselman
& Kesselman, a member of PricewaterhouseCoopers International Limited,
served as our independent public accountants for the fiscal years ended December
31, 2007 and 2008, for which audited financial statements appear in this Annual
Report on Form 20-F.




The
following table presents the aggregate fees for professional services rendered
by such accountants to us during their respective term as our principal
accountants in 2007 and 2008.




2008
                  
                  
                  2007(NIS
      in thousands)
                  
                  
                  (NIS
      in thousands)Audit
      Fees (1)
                  
                  
                  3,075
                  
                  
                  
                  2,837Audit-Related
      fees (2)
                  
                  
                  695
                  
                  
                  
                  657Tax
      Fees (3)
                  
                  
                  259
                  
                  
                  
                  64All
      Other Fees (4)
                  
                  
                  1,079
                  
                  
                  
                  775TOTAL
                  
                  
                  5,108
                  
                  
                  
                  4,333





(1)
            Audit
      Fees consist of fees billed for the annual audit services engagement and
      other audit services, which are those services that only the external
      auditor can reasonably provide, and include the group audit; statutory
      audits; comfort letters and consents; attest services; assistance with and
      review of documents filed with the SEC and Sarbanes-Oxley Act
      compliance.




(2)
            Audit-related
      services in connection with BSRE's shelf prospectus and in connection with
      reports delivered to the Company's controlling
  shareholder.




(3)
            Tax
      Fees include fees billed for tax compliance services, including the
      preparation of original and amended tax returns and claims for refund; tax
      consultations, such as assistance and representation in connection with
      tax audits and appeals, tax advice related to mergers and acquisitions,
      restructuring, transfer pricing, and requests for rulings or technical
      advice from taxing authority; tax planning services; and expatriate tax
      planning and services.




(4)
            Other
      Fees mainly relate to consulting services in connection with the transfer
      by the Company of real estate assets to BSRE and due diligence services in
      connection with several potential acquisitions by the
    Company.




158




Audit
Committee Pre-Approval Policies and Procedures




One of
our audit committee’s main roles is to assist the board of directors in
fulfilling its responsibility for oversight of the quality and integrity of the
accounting, auditing and reporting practices of the Company. The Audit Committee
oversees the appointment, compensation, and oversight of the public accounting
firm engaged to prepare or issue an audit report on the financial statements of
the Company. Our audit committee has adopted a pre-approval policy for audit and
non-audit services.




ITEM
      16D.
              EXEMPTIONS
      FROM THE LISTING STANDARDS FOR AUDIT
COMMITTEES.




Not
applicable.




ITEM
      16E.
              PURCHASES
      OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
    PURCHASERS.




None.




ITEM
      16F.
              CHANGE
      IN REGISTRANT'S CERTIFYING
ACCOUNTANT.




Not
applicable.




ITEM
      16G.
              CORPORATE
      GOVERNANCE




Below is
a summary of the significant differences between our corporate governance
practices as a foreign private issuer and those required of U.S. domestic
companies under New York Stock Exchange ("NYSE") listing standards.




Our
corporate governance practices are derived from (i) the Israeli Companies Law,
1999 and the regulations promulgated thereunder, (ii) our Articles of
Association and (iii) the rules of the NYSE applicable to foreign private
issuers.  As a foreign private issuer we are permitted to follow home
country practice in lieu of certain provisions of Section 303A of the NYSE
Corporate Governance Rules.




Majority of Independent
Directors:  Under NYSE Rule 303A.01, domestic listed companies
must have a majority of independent directors.  We do not have a
majority of independent directors serving on our board of directors, although
all of our audit committee members are independent directors.




Separate meetings of non-management
directors: Under NYSE Rule 303A.03, the non-management directors of each
domestic listed company must meet at regularly scheduled executive sessions
without management.  Our independent directors do not meet separately
from directors who are not independent, other than in the context of audit
committee meetings.




159




Nominating/corporate governance
committee:  Under NYSE Rule 303A.04, a domestic listed company
must have a nominating/corporate governance committee composed entirely of
independent directors.  We do not have such a committee.




Compensation
Committee:  Under NYSE Rule 303A.05, a domestic listed company
must have a compensation committee composed entirely of independent
directors.  We do have a compensation committee although it is not
composed entirely of independent directors.




Audit Committee: Under NYSE
Rule 303A.06, listed companies are required to have an audit committee that
complies with the requirements of Rule 10A-3 of the Securities and Exchange Act
of 1934.  Rule 10A-3 requires the audit committee of a U.S. company to
be directly responsible for the appointment, compensation, retention and
oversight of the work of any registered public accounting firm engaged for the
purpose of preparing or issuing an audit report or performing other audit,
review, or attest services, and that each such firm must report directly to the
audit committee.




Pursuant
to the Israeli Companies Law, our auditors are appointed by the shareholders at
the annual meeting of shareholders. Our shareholders have delegated to the board
of directors and audit committee the authority to determine the amount to be
paid to our auditors. Our audit committee is responsible for recommending to the
shareholders the appointment of our auditors and for assisting the board of
directors in overseeing the work of our auditors. In addition, pursuant to the
Israeli Companies Law, our financial statements must be approved by our board of
directors.




Equity Compensation Plans:
Under NYSE Rule 303A.08, shareholders must be given the opportunity to vote on
all equity-compensation plans and material revisions thereto, with certain
limited exemptions as described in the Rule.




We do not obtain shareholder approval
of all our equity-compensation plans.  Pursuant to the Israeli
Companies Law, transactions with officers, directors, and controlling
shareholders regarding the terms of their office and employment, including any
compensation in securities, require special approval (including approval of the
board of directors in the case of officers, and including approval of the board
of directors and shareholders in the case of directors and controlling
shareholders).




Corporate governance
guidelines: Under NYSE Rule 303A.09, domestic listed companies must adopt
and disclose their corporate governance guidelines.   We have
adopted a written Policy Regarding the Usage of Insider Information as well as
Code of Ethics, although these do not satisfy the corporate governance
guidelines referred to in Rule 303A.09.


160




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.




ITEM
      19.
            EXHIBITS




The
exhibits filed with or incorporated into this Annual Report are listed in the
index of exhibits below.




Exhibit No.
                
                Description1.1
                
                Memorandum
      of Association of the Registrant (incorporated by reference to Exhibit 3.1
      to the Registration Statement on Form F-1 (File No.
      333-05024)).1.2
                
                Articles
      of Association of the Registrant.2.1
                
                Form
      of Amended and Restated Deposit Agreement among Blue Square-Israel Ltd.,
      The Bank of New York as Depositary, and all Owners and Holders from time
      to time of American Depositary Shares issued thereunder (incorporated by
      reference to Exhibit (a) to the Registration Statement on Form F-6 (File
      No. 333-05158)).4.1
                
                Service
      Agreement made and entered into on the 1st day of January 1990
      between Blue Square Chain (Super Super) Ltd. and Blue Square Chain (Hyper
      Hyper) Ltd. (incorporated by reference to Exhibit 10.10 to the
      Registration Statement on Form F-1 (File No.
  333-05024)).4.2
                
                Supply
      Agreement made and entered into on the 1st day of January 1990
      between Blue Square Chain (Super Super) Ltd. and Blue Square Chain (Hyper
      Hyper) Ltd. (incorporated by reference to Exhibit 10.11 to the
      Registration Statement on Form F-1 (File No.
  333-05024)).4.3
                
                Management
      Agreement made and entered into on July 23, 1996 between Blue Square
      Chain Investments & Properties Ltd. and the Registrant (incorporated
      by reference to Exhibit 10.12 to the Registration Statement on Form F-1
      (File No. 333-05024)).4.4
                
                An
      Agreement to Loan Employees made and entered into on July 23, 1996
      between Blue Square Chain Properties (Hyper Hyper) Ltd. and the Registrant
      (incorporated by reference to Exhibit 10.13 to the Registration Statement
      on Form F-1 (File No. 333-05024)).4.5
                
                Agreement
      made and entered into on July 25, 1996 between the Registrant and
      Blue Square Chain (Hyper Hyper) Ltd. regarding property selection
      (incorporated by reference to Exhibit 10.14 to the Registration Statement
      on Form F-1 (File No. 333-05024)).4.6
                
                Registration
      Rights Agreement, dated as of July 25, 1996, by and among the
      Registrant and Co-Op Blue Square Consumers Cooperative Society Ltd.
      (incorporated by reference to Exhibit 10.15 to the Registration Statement
      on Form F-1 (File No. 333-05024)).4.7
                
                Letter,
      dated July 1, 1996, by Co-Op Blue Square Consumers Cooperative
      Society Ltd. indemnifying the Registrant against certain real estate tax
      liabilities (incorporated by reference to Exhibit 10.17 to the
      Registration Statement on Form F-1 (File No.
  333-05024)).




161





Exhibit No.
                
                Description4.8
                
                Letter,
      dated May 21, 1993 and March 18, 1993, by Co-Op Blue Square
      Consumers Cooperative Society Ltd. indemnifying Blue Square Chain
      Investments & Properties Ltd. against certain real estate tax
      liabilities (incorporated by reference to Exhibit 10.18 to the
      Registration Statement on Form F-1 (File No.
  333-05024)).4.9
                
                Form
      of Letter of Exemption and Indemnity adopted in February 2001
      (incorporated by reference to Exhibit 4.13 to Blue Square’s Annual Report
      on Form 20-F for the year ended December 31, 2000).4.10
                
                Form
      of Letter of Exemption and Indemnity (English translation accompanied by
      the Hebrew original) (incorporated by reference to Exhibit 4.14 to Blue
      Square’s Annual Report on Form 20-F for the year ended December 31,
      2001).4.11
                
                Form
      of Letter of Indemnity adopted in June 2008 (English
      translation).4.12
                
                Special
      Collective Agreement made on the 28th day of May 1996 between Co-Op
      Blue Square Consumers Cooperative Society Ltd., the Registrant and The New
      Federation of Labor in Israel/The Federation of Clerical, Administrative
      and Services Employees and Consumers Cooperative Union-Central Cooperative
      Society Ltd. (incorporated by reference to Exhibit 10.4 to the
      Registration Statement on Form F-1 (File No.
  333-05024)).4.13
                
                Special
      Collective Agreement made on the 3rd day of September 2000 between
      Blue Square and The New Federation of Labor in Israel. The Federation of
      Clerical, Administrative and Services Employees / the Commercial Section
      Employees and the committee of Blue Square employees. (English summary
      accompanied by the Hebrew original) (incorporated by reference to Exhibit
      4.16 to Blue Square’s Annual Report on Form 20-F for the year ended
      December 31, 2001).4.14
                
                Collective
      Agreement, made on August 13, 2003, by and among Blue Square – Israel Ltd.
      and The New Federation of Labor in Israel/The Federation of Clerical,
      Administrative and Services Employees and the National Committee of the
      Blue Square Co-Op Employees (English translation) (incorporated by
      reference to Exhibit 4.15 to Blue Square’s Annual Report on Form 20-F for
      the year ended December 31, 2003).4.15
                
                Collective
      Agreement, made on October 15, 2003, by and among Blue Square - Israel
      Ltd. and The New Federation of Labor in Israel/The Federation of Clerical,
      Administrative and Services Employees and the National Workers Committee
      of Blue Square-Israel Ltd (English translation) (incorporated by reference
      to Exhibit 4.16 to Blue Square’s Annual Report on Form 20-F for the year
      ended December 31, 2003).4.16
                
                Special
      Collective Bargaining Agreement made on the 21st
      day of January 2005 among Blue Square, the Histadrut and the National
      Committee of Blue Square-Israel. (English translation) (incorporated by
      reference to Exhibit 4.15 to Blue Square’s Annual Report on Form 20-F for
      the year ended December 31, 2004).4.17
                
                Special
      Collective Bargaining Agreement made on April 26, 2006 among Blue Square,
      the MAOF Histadrut and Blue Square-Israel Employees' Union (English
      translation) (incorporated by reference to Exhibit 4.16 to Blue Square’s
      Annual Report on Form 20-F for the year ended December 31,
      2006).4.18
                
                Special
      Collective Bargaining Agreement made on May 29, 2006 among Blue Square,
      the MAOF Histadrut and Blue Square-Israel Employees' Union (English
      translation) (incorporated by reference to Exhibit 4.17 to Blue Square’s
      Annual Report on Form 20-F for the year ended December 31,
      2006).


162





Exhibit No.
                
                Description4.19
                
                Special
      Collective Bargaining Agreement made on July 16, 2007 among Blue Square,
      the MAOF Histadrut and Blue Square-Israel Employees' Union (English
      translation) (incorporated by reference to Exhibit 4.19 to Blue Square’s
      Annual Report on Form 20-F for the year ended December 31,
      2007).4.20
                
                Special
      Collective Bargaining Agreement made on April 5, 2009 among Blue Square,
      Blue Square Chain Investments & Properties Ltd., the MAOF Histadrut
      and Blue Square-Israel Employees' Union (English
    translation).4.21
                
                Deed
      of Trust made on August 5, 2003, by and between Blue Square – Israel Ltd.
      and Israel Discount Bank Trust Company Ltd., together with second schedule
      (English translation) (incorporated by reference to Exhibit 4.18 to Blue
      Square’s Annual Report on Form 20-F for the year ended December 31,
      2003).4.22
                
                First
      Schedule to Deed of Trust – Debenture Certificate for Registered Debenture
      (Series A) of NIS 1 par value each (out of series of NIS 200,000,000 par
      value Debentures (Series A)) (English translation) (incorporated by
      reference to Exhibit 4.19 to Blue Square’s Annual Report on Form 20-F for
      the year ended December 31, 2003).4.23
                
                First
      Schedule to Deed of Trust – Debenture Certificate for Registered Debenture
      (Series B) of NIS 1 par value each (out of series of NIS 200,000,000 par
      value Debentures (Series B)) (English translation) (incorporated by
      reference to Exhibit 4.20 to Blue Square’s Annual Report on Form 20-F for
      the year ended December 31, 2003).4.24
                
                Agreement
      between the Registrant and Blue Square Chain (Hyper Hyper) Ltd.
      (incorporated by reference to Exhibit 4.21 to Blue Square’s Annual Report
      on Form 20-F for the year ended December 31, 2002).4.25
                
                General
      services framework and expenses allotment agreement, dated October 11,
      2005, among Blue Square, Blue Square Chain Investments & Properties
      Ltd. and Blue Square Chain (Hyper Hyper) Ltd., as amended (incorporated by
      reference to Exhibit 4.21 to Blue Square’s Annual Report on Form 20-F for
      the year ended December 31, 2005).4.26
                
                Transfer
      Agreement, dated June 21, 2006, between Blue Square and Blue Square Real
      Estate Ltd. (English translation) (incorporated by reference to Exhibit
      4.23 to Blue Square’s Annual Report on Form 20-F for the year ended
      December 31, 2006).4.27
                
                Split
      Agreement, dated April 2, 2006, between Blue Square and Blue Square Real
      Estate Ltd. (English translation) (incorporated by reference to Exhibit
      4.24 to Blue Square’s Annual Report on Form 20-F for the year ended
      December 31, 2006).4.28
                
                Lease
      Agreement, dated August 13, 2006, between Blue Square and Blue Square Real
      Estate Ltd. (English translation) (incorporated by reference to Exhibit
      4.25 to Blue Square’s Annual Report on Form 20-F for the year ended
      December 31, 2006).4.29
                
                Lease
      Agreement, dated June 23, 2006, between Blue Square and Blue Square Chain
      Investments & Properties Ltd Blue Square Real Estate Ltd (assigned to
      BSRE) (English translation) (incorporated by reference to Exhibit 4.26 to
      Blue Square’s Annual Report on Form 20-F for the year ended December 31,
      2006).4.30
                
                Service
      Agreement, dated August 13, 2006, between Blue Square and Blue Square Real
      Estate Ltd. (English translation) (incorporated by reference to Exhibit
      4.27 to Blue Square’s Annual Report on Form 20-F for the year ended
      December 31, 2006).


163





Exhibit No.
                
                Description4.31
                
                Underwriting
      Agreement, dated August 15, 2006, among Blue Square Real Estate Ltd., and
      Poalim I.B.I Underwriting and Issues Ltd., Africa-Israel Issues Ltd.,
      Discount Underwriting and Issues Ltd. and various other underwriters
      (English translation) (incorporated by reference to Exhibit 4.28 to Blue
      Square’s Annual Report on Form 20-F for the year ended December 31,
      2006).4.32
                
                Deed
      of Trust (for Series A Debenture) made on August 14, 2006, by and between
      Blue Square Real Estate Ltd. and Hermetic Trust (1975) Ltd., together with
      second schedule (English translation) (incorporated by reference to
      Exhibit 4.29 to Blue Square’s Annual Report on Form 20-F for the year
      ended December 31, 2006).4.33
                
                First
      Schedule to Deed of Trust - Debenture Certificate for Registered
      Debentures (Series A) of NIS 1 par value each (out of series of NIS
      100,000,000 par value Debentures (Series A)) (English translation)
      (incorporated by reference to Exhibit 4.30 to Blue Square’s Annual Report
      on Form 20-F for the year ended December 31, 2006).4.34
                
                Deed
      of Trust (for Series B Debenture) made on August 14, 2006, by and between
      Blue Square Real Estate Ltd. and Hermetic Trust (1975) Ltd., together with
      second schedule (English translation) (incorporated by reference to
      Exhibit 4.31 to Blue Square’s Annual Report on Form 20-F for the year
      ended December 31, 2006).4.35
                
                First
      Schedule to Deed of Trust - Debenture Certificate for Registered
      Debentures (Series B) of NIS 1 par value each (out of series of NIS
      650,000,000 par value Debentures (Series B)) (English translation)
      (incorporated by reference to Exhibit 4.32 to Blue Square’s Annual Report
      on Form 20-F for the year ended December 31, 2006).4.36
                
                Document
      of Principles of Transaction, dated July 26, 2007, among Blue Square and
      Orin Provizor Holdings Ltd., M.A.Sh.- M.I.S. Ltd., Mr. Guy Provizor, and
      Eden Natural Health Market Ltd., as amended (English translation)
      (incorporated by reference to Exhibit 4.35 to Blue Square’s Annual Report
      on Form 20-F for the year ended December 31, 2007).4.37
                
                Sale
      Agreement, made on August 2, 2007, between Kfar Hasha'ashuim Central
      Warehouse Ltd. and Eldar Gil & Mahoney Assets Ltd., as amended
      (English translation) (incorporated by reference to Exhibit 4.36 to Blue
      Square’s Annual Report on Form 20-F for the year ended December 31,
      2007).4.38
                
                Share
      Purchase Agreement, dated August 3, 2008, between Bee Group Retail Ltd.
      and Twikor Ltd., Mr. Avner Katz, Mr. Doron Yanai, Mr. Ronen Levy, Avi Katz
      Marketing Ltd. and Levy R.S. Managements and Investments Ltd. (English
      translation).8.1
                
                List
      of Subsidiaries (incorporated by reference to Exhibit 8 to Blue Square’s
      Annual Report on Form 20-F for the year ended December 31,
      2007).12.(a).1
                
                Certification
      by CEO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
      Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes
      Oxley Act of 2002.12.(a).2
                
                Certification
      by CFO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
      Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes
      Oxley Act of 2002.13.(a).1
                
                Certification
      of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.14.(a).1
                
                Consent
      of Independent Registered Public Accounting Firm from Kesselman &
      Kesselman, certified public accountants
(Isr.).


164





Exhibit No.
                
                Description14.(a).2
                
                Consent
      of an Expert dated June 23, 2009.14.(a).3
                
                Consent
      of an Expert dated June 23, 2009.14.(a).4
                
                Consent
      of an Expert dated June 23,
2009.


165




BLUE
SQUARE - ISRAEL LTD.




CONSOLIDATED
FINANCIAL STATEMENTS




AS OF
DECEMBER 31, 2008





TABLE OF
CONTENTS





PageREPORT
      OF INDEPENDANT REGISTERED PUBLIC ACCOUNTING FIRM
                              
                              F-2-F-3CONSOLIDATED
      FINANCIAL STATEMENTS IN THOUSANDS OF NEW ISRAELI SHEKELS
      (NIS):Balance
      sheets
                              
                              F-4-F-5Income
      statements
                              
                              F-6Statements
      of recognized income and expense
                              
                              F-7Statements
      of cash flows
                              
                              F-8-F10Notes
      to financial statements
                              
                              F-11-F-93APPENDIX
      - DETAILS OF PRINCIPAL SUBSIDIARIES, PROPORTIONATELY CONSOLIDATED
      COMPANIES AND ASSOCIATED COMPANIES
                              
                              F-94




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


F-1


Report
of Independent Registered




Public
Accounting Firm


To the
shareholders of




BLUE
SQUARE - ISRAEL LTD.





We have
completed integrated audits of Blue Square - Israel Ltd. and its subsidiaries
and proportionately consolidated companies (collectively - "the Company")
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2008, in accordance with the standards of the
Public Company Accounting Oversight Board (United States).Our opinions, based on
our integrated audits, are presented below.





Consolidated
financial statements





We have
audited the consolidated balance sheets of the Company as of December 31, 2007
and 2008 and the consolidated income statements, recognized income and expense
and cash flows for each of the years ended on those dates. These consolidated
financial statements are the responsibility of the Company’s Board of Directors
and management. Our responsibility is to express an opinion on these financial
statements based on our integrated audits.





We
conducted our audits in accordance with auditing standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance 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 consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by the Company’s Board
of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the financial position of the Company as of
December 31, 2007 and 2008 and the results of operations and cash flows for each
of the years ended on those dates, in conformity with International Financial
Reporting Standards ("IFRS") as issued by the International Accounting Standards
Board ("IASB").





Internal
control over financial reporting





Also, in
our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company’s Board of Directors and management are responsible for maintaining
effective internal control over financial reporting and management is
responsible for the assessment of the effectiveness of internal control over
financial reporting included in the accompanying Management's Annual Report on
Internal Control over Financial Reporting appearing under Item 15(b). Our
responsibility is to express an opinion on the effectiveness of the Company’s
internal control over financial reporting based on our integrated audit. We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also includes performing such other procedures as we consider
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.


F-2


A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





Haifa,
      Israel
                
                /s/
      Kesselman & KesselmanJune
      25, 2009
                
                Certified
      Public Accountants (Isr.)A
      member of PricewaterhouseCoopers
                  International
      Limited




F-3


BLUE
SQUARE – ISRAEL LTD.





CONSOLIDATED
BALANCE SHEETS





December
      31
              
              
              Convenience
                translation
                (note
      2)
                December
      31,2007
              
              
              2008
              
              
              2008Note
              
              
              NIS
              
              
              U.S.
      dollarsIn
      thousandsAssetsCURRENT
      ASSETS:Cash
      and cash equivalents
              
              
              14
              
              
              
              56,410
              
              
              
              95,325
              
              
              
              25,072Short-term
      bank deposit
              
              
              
              
              
              
              103,498
              
              
              
              206
              
              
              
              54Marketable
      securities
              
              
              11
              
              
              
              199,394
              
              
              
              171,849
              
              
              
              45,200Trade
      receivables
              
              
              13a
              
              
              
              776,251
              
              
              
              729,970
              
              
              
              191,996Other
      accounts receivable
              
              
              13b
              
              
              
              99,841
              
              
              
              87,624
              
              
              
              23,047Income
      taxes receivable
              
              
              
              
              
              
              23,062
              
              
              
              74,446
              
              
              
              19,581Inventories
              
              
              
              
              
              
              453,944
              
              
              
              497,080
              
              
              
              130,742Total
      current assets
              
              
              
              
              
              
              1,712,400
              
              
              
              1,656,500
              
              
              
              435,692NON-CURRENT
      ASSETS:Investments
      in associates
              
              
              9
              
              
              
              4,948
              
              
              
              4,915
              
              
              
              1,293Derivatives
      financial instruments
              
              
              12
              
              
              
              10,500
              
              
              
              5,248
              
              
              
              1,380Prepaid
      expenses in respect of operating leases
              
              
              
              
              
              
              199,679
              
              
              
              192,426
              
              
              
              50,612Other
      long-term receivables
              
              
              13c
              
              
              
              48,289
              
              
              
              1,554
              
              
              
              409Property,
      plant and equipment
              
              
              6
              
              
              
              1,613,515
              
              
              
              1,701,222
              
              
              
              447,454Investment
      property
              
              
              7
              
              
              
              315,778
              
              
              
              434,232
              
              
              
              114,211Intangible
      assets
              
              
              8
              
              
              
              280,420
              
              
              
              404,422
              
              
              
              106,371Deferred
      taxes
              
              
              21
              
              
              
              33,542
              
              
              
              44,508
              
              
              
              11,706Total
      non-current assets
              
              
              
              
              
              
              2,506,671
              
              
              
              2,788,527
              
              
              
              733,436Total
      assets
              
              
              
              
              
              
              4,219,071
              
              
              
              4,445,027
              
              
              
              1,169,128





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





June
      25, 2009Date
      of approval of the
              
              David
      Wiessman
              
              Zeev
      Vurembrand
              
              Dror
      Moranfinancial
      statements
              
              Chairman
      of the Board
                of
      Directors
              
              President
      and Chief
                Executive
      Officer
              
              Vice
      President and
                Chief
      Financial Officer


F-4





December
      31
              
              
              Convenience
                translation
                (note
      2)
                December
      31,2007
              
              
              2008
              
              
              2008Note
              
              
              NIS
              
              
              U.S.
      dollarsIn
      thousandsLiabilities
      and equityCURRENT
      LIABILITIES:Credit  and
      loans from banks and others
              
              
              19
              
              
              
              171,010
              
              
              
              210,901
              
              
              
              55,471Current
      maturities of  debentures and convertible
    debentures
              
              
              19
              
              
              
              69,859
              
              
              
              25,999
              
              
              
              6,838Trade
      payables
              
              
              
              
              
              
              981,188
              
              
              
              1,006,386
              
              
              
              264,698Other
      accounts payable and accrued expenses
              
              
              18
              
              
              
              404,929
              
              
              
              437,810
              
              
              
              115,153Income
      taxes payable
              
              
              
              
              
              
              2,905
              
              
              
              6,933
              
              
              
              1,824Provisions
              
              
              23
              
              
              
              35,073
              
              
              
              43,397
              
              
              
              11,414Total
      current liabilities
              
              
              
              
              
              
              1,664,964
              
              
              
              1,731,426
              
              
              
              455,398NON
      CURRENT LIABILITIES:Long-term
      loans from banks, net of current maturities
              
              
              19
              
              
              
              248,488
              
              
              
              341,586
              
              
              
              89,844Convertible
      debentures, net of current maturities
              
              
              19
              
              
              
              193,706
              
              
              
              130,525
              
              
              
              34,331Debentures,
      net of current maturities
              
              
              19
              
              
              
              749,018
              
              
              
              985,844
              
              
              
              259,296Other
      liabilities
              
              
              20
              
              
              
              11,646
              
              
              
              39,925
              
              
              
              10,501Derivatives
      financial instruments
              
              
              12
              
              
              
              9,968
              
              
              
              9,481
              
              
              
              2,494Liabilities
      for employee rights, net of amounts funded
              
              
              22
              
              
              
              35,986
              
              
              
              49,911
              
              
              
              13,128Deferred
      taxes
              
              
              21
              
              
              
              57,615
              
              
              
              60,327
              
              
              
              15,867Total
      long-term liabilities
              
              
              
              
              
              
              1,306,427
              
              
              
              1,617,599
              
              
              
              425,461Total
      liabilities
              
              
              
              
              
              
              2,971,391
              
              
              
              3,349,025
              
              
              
              880,859EQUITY:Equity
      attributable to equity holders of the Company:Ordinary
      shares
              
              
              15
              
              
              
              57,094
              
              
              
              57,094
              
              
              
              15,017Additional
      paid-in capital
              
              
              15
              
              
              
              1,018,405
              
              
              
              1,018,405
              
              
              
              267,860Other
      reserves
              
              
              16
              
              
              
              1,415
              
              
              
              (261
              )
              
              
              (69
              )Accumulated
      deficit
              
              
              17
              
              
              
              (107,262
              )
              
              
              (154,719
              )
              
              
              (40,694
              )969,652
              
              
              
              920,519
              
              
              
              242,114Minority
      interest
              
              
              
              
              
              
              278,028
              
              
              
              175,483
              
              
              
              46,155Total
      equity
              
              
              
              
              
              
              1,247,680
              
              
              
              1,096,002
              
              
              
              288,269Total
      liabilities and equity
              
              
              
              
              
              
              4,219,071
              
              
              
              4,445,027
              
              
              
              1,169,128





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


F-5


BLUE
SQUARE – ISRAEL LTD.





CONSOLIDATED
INCOME STATEMENTS





Conveniencetranslation(note
      2)Year
      endedYear
      ended December 31
                                  
                                  
                                  December
      31,2007
                                  
                                  
                                  2008
                                  
                                  
                                  2008Note
                                  
                                  
                                  NIS
                                  
                                  
                                  U.S.
      DollarsIn
      thousands (except earning per share data)Sales
                                  
                                  
                                  
                                  
                                  
                                  6,981,984
                                  
                                  
                                  
                                  7,429,121
                                  
                                  
                                  
                                  1,954,003Cost
      of sales
                                  
                                  
                                  
                                  
                                  
                                  5,129,578
                                  
                                  
                                  
                                  5,369,149
                                  
                                  
                                  
                                  1,412,191Gross
      profit
                                  
                                  
                                  
                                  
                                  
                                  1,852,406
                                  
                                  
                                  
                                  2,059,972
                                  
                                  
                                  
                                  541,812Selling,
      general and administrative expenses
                                  
                                  
                                  
                                  
                                  
                                  1,563,208
                                  
                                  
                                  
                                  1,794,720
                                  
                                  
                                  
                                  472,046Operating
      profit before other gains and losses and net gain from adjustment of
      investment property to fair value
                                  
                                  
                                  
                                  
                                  
                                  289,198
                                  
                                  
                                  
                                  265,252
                                  
                                  
                                  
                                  69,766Other
      gains
                                  
                                  
                                  24
                                  
                                  
                                  
                                  15,835
                                  
                                  
                                  
                                  12,233
                                  
                                  
                                  
                                  3,218Other
      losses
                                  
                                  
                                  24
                                  
                                  
                                  
                                  (12,755
                                  )
                                  
                                  
                                  (
      14,716
                                  )
                                  
                                  
                                  (3,870
                                  )Net
      gain from adjustment of investment property to fair value
                                  
                                  
                                  
                                  
                                  
                                  
                                  10,456
                                  
                                  
                                  
                                  19,067
                                  
                                  
                                  
                                  5,015Operating
      profit
                                  
                                  
                                  
                                  
                                  
                                  
                                  302,734
                                  
                                  
                                  
                                  281,836
                                  
                                  
                                  
                                  74,129Finance
      income
                                  
                                  
                                  27
                                  
                                  
                                  
                                  60,978
                                  
                                  
                                  
                                  60,700
                                  
                                  
                                  
                                  15,965Finance
      expenses
                                  
                                  
                                  27
                                  
                                  
                                  
                                  (118,297
                                  )
                                  
                                  
                                  (166,295
                                  )
                                  
                                  
                                  (43,739
                                  )Finance
      expenses, net
                                  
                                  
                                  
                                  
                                  
                                  
                                  57,319
                                  
                                  
                                  
                                  105,595
                                  
                                  
                                  
                                  27,774Share
      in profit (loss) of associates
                                  
                                  
                                  
                                  
                                  
                                  
                                  186
                                  
                                  
                                  
                                  (33
                                  )
                                  
                                  
                                  (9
                                  )Income
      before taxes on income
                                  
                                  
                                  
                                  
                                  
                                  
                                  245,601
                                  
                                  
                                  
                                  176,208
                                  
                                  
                                  
                                  46,346Taxes
      on income
                                  
                                  
                                  28
                                  
                                  
                                  
                                  69,779
                                  
                                  
                                  
                                  43,806
                                  
                                  
                                  
                                  11,522Profitfor the
      year
                                  
                                  
                                  
                                  
                                  
                                  
                                  175,822
                                  
                                  
                                  
                                  132,402
                                  
                                  
                                  
                                  34,824Attributable
      to:Equity
      holders of the company:
                                  
                                  
                                  
                                  
                                  
                                  
                                  143,628
                                  
                                  
                                  
                                  104,586
                                  
                                  
                                  
                                  27,508Minority
      interests
                                  
                                  
                                  
                                  
                                  
                                  
                                  32,194
                                  
                                  
                                  
                                  27,816
                                  
                                  
                                  
                                  7,316Earningsper Ordinary share
      or ADS attributable to equity holders of the Company:
                                  
                                  
                                  29Basic
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.39
                                  
                                  
                                  
                                  2.41
                                  
                                  
                                  
                                  0.63Diluted
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.39
                                  
                                  
                                  
                                  1.62
                                  
                                  
                                  
                                  0.43





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


F-6


BLUE
SQUARE – ISRAEL LTD.





CONSOLIDATED
STATEMENTS OF RECOGNIZED INCOME AND EXPENSE





Year ended December 31,
              
              
              Convenience
                translation
                (note 2)
                Year ended
                December 31,2007
              
              
              2008
              
              
              2008Note
              
              
              NIS
              
              
              U.S. dollarsIn
      thousandsItems
      net of taxAvailable-for-sale
      financial assets
              
              
              11
              
              
              
              1,567
              
              
              
              (2,214
              )
              
              
              (582
              )Actuarial
      loss on employee rights obligations
              
              
              22
              
              
              
              (646
              )
              
              
              (10,346
              )
              
              
              (2,721
              )Net
      income (loss) recognized directly in equity
              
              
              
              
              
              
              921
              
              
              
              (12,560
              )
              
              
              (3,303
              )Profit
      for the year
              
              
              
              
              
              
              175,822
              
              
              
              132,402
              
              
              
              34,824Total
      recognized income for the year
              
              
              
              
              
              
              176,743
              
              
              
              119,842
              
              
              
              31,521Attributable
      to:Equity
      holders of the Company
              
              
              
              
              
              
              144,614
              
              
              
              92,898
              
              
              
              24,434Minority
      interest
              
              
              
              
              
              
              32,129
              
              
              
              26,944
              
              
              
              7,087





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


F-7


BLUE
SQUARE – ISRAEL LTD.




CONSOLIDATED
STATEMENTS OF CASH FLOWS





Conveniencetranslation(note
      2)Year
      ended
                          
                          
                          Year
      endedDecember
      31,
                          
                          
                          December
      31,2007
                          
                          
                          2008
                          
                          
                          2008NIS
                          
                          
                          U.S
      dollarsIn
      thousandsCASH
      FLOWS FROM OPERATING ACTIVITIES:Income
      before taxes on income
                          
                          
                          245,601
                          
                          
                          
                          176,208
                          
                          
                          
                          46,346Income
      tax paid
                          
                          
                          (60,903
                          )
                          
                          
                          (94,212
                          )
                          
                          
                          (24,779
                          )Adjustments
      to reflect cash flows from operating activities (a)
                          
                          
                          163,781
                          
                          
                          
                          327,777
                          
                          
                          
                          86,211Net
      cash provided by operating activities
                          
                          
                          348,479
                          
                          
                          
                          409,773
                          
                          
                          
                          107,778CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property, plant and equipment
                          
                          
                          (174,275
                          )
                          
                          
                          (211,646
                          )
                          
                          
                          (55,667
                          )Proceeds
      from sale of property, plant and equipment
                          
                          
                          1,478
                          
                          
                          
                          1,559
                          
                          
                          
                          410Purchase
      of  investment property
                          
                          
                          (21,339
                          )
                          
                          
                          (69,749
                          )
                          
                          
                          (18,344
                          )Proceeds
      from sale of investment property
                          
                          
                          14,978
                          
                          
                          
                          6,567
                          
                          
                          
                          1,727Payments
      on account of real estate
                          
                          
                          (45,825
                          )
                          
                          
                          -
                          
                          
                          
                          -Additional
      investment in subsidiaries
                          
                          
                          (5,000
                          )
                          
                          
                          (186,403
                          )
                          
                          
                          (49,028
                          )Proceeds
      from realization of investment in subsidiary
                          
                          
                          394
                          
                          
                          
                          -
                          
                          
                          
                          -Investment
      in intangible assets
                          
                          
                          (15,021
                          )
                          
                          
                          (30,372
                          )
                          
                          
                          (7,988
                          )Collection
      of  short-term bank deposit, net
                          
                          
                          398,513
                          
                          
                          
                          101,281
                          
                          
                          
                          26,639Collection  of
      long-term receivables
                          
                          
                          409
                          
                          
                          
                          1,250
                          
                          
                          
                          329Proceeds
      from sale of marketable securities
                          
                          
                          13,340
                          
                          
                          
                          185,104
                          
                          
                          
                          48,686Purchase
      of marketable securities
                          
                          
                          (175,258
                          )
                          
                          
                          (169,747
                          )
                          
                          
                          (44,647
                          )Acquisition
      of subsidiaries (b)
                          
                          
                          (161,876
                          )
                          
                          
                          -
                          
                          
                          
                          -Interest
      received
                          
                          
                          55,170
                          
                          
                          
                          17,778
                          
                          
                          
                          4,676Net
      cash used in investing activities
                          
                          
                          (114,312
                          )
                          
                          
                          (354,378
                          )
                          
                          
                          (93,207
                          )CASH
      FLOWS FROM FINANCING ACTIVITIES:Repayment
      of convertible debentures
                          
                          
                          (16,728
                          )
                          
                          
                          -
                          
                          
                          
                          -Dividends
      paid to shareholders
                          
                          
                          (280,000
                          )
                          
                          
                          (150,000
                          )
                          
                          
                          (39,453
                          )Issuance
      of debentures
                          
                          
                          -
                          
                          
                          
                          121,259
                          
                          
                          
                          31,894Dividends
      paid to minority shareholders of subsidiaries
                          
                          
                          (50,706
                          )
                          
                          
                          (22,077
                          )
                          
                          
                          (5,807
                          )Receipt
      of long-term loans
                          
                          
                          269,364
                          
                          
                          
                          231,398
                          
                          
                          
                          60,862Repayments
      of long-term loans
                          
                          
                          (215,143
                          )
                          
                          
                          (130,571
                          )
                          
                          
                          (34,343
                          )Repayments
      of credit of long-term payables
                          
                          
                          (1,740
                          )
                          
                          
                          (1,740
                          )
                          
                          
                          (458
                          )Short-term
      credit from banks, net
                          
                          
                          3,396
                          
                          
                          
                          15,689
                          
                          
                          
                          4,127Interest
      paid
                          
                          
                          (72,527
                          )
                          
                          
                          (89,244
                          )
                          
                          
                          (23,473
                          )Net
      cash used in financing activities
                          
                          
                          (364,084
                          )
                          
                          
                          (25,286
                          )
                          
                          
                          (6,651
                          )INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
                          
                          
                          (129,917
                          )
                          
                          
                          30,109
                          
                          
                          
                          7,920CASH
      AND CASH EQUIVALENTS AT BEGINNING OF YEAR
                          
                          
                          182,946
                          
                          
                          
                          53,029
                          
                          
                          
                          13,948CASH
      AND CASH EQUIVALENTS AT END OF YEAR (see note 14)
                          
                          
                          53,029
                          
                          
                          
                          83,138
                          
                          
                          
                          21,868


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


F-8


BLUE
SQUARE – ISRAEL LTD.





CONSOLIDATED
STATEMENTS OF CASH FLOWS





Conveniencetranslation(note
      2)Year
      ended
                  
                  
                  Year
      endedDecember
      31,
                  
                  
                  December
      31,2007
                  
                  
                  2008
                  
                  
                  2008NIS
                  
                  
                  U.S
      dollarsIn
      thousands(a)
                  Adjustments
      to reflect cash flows from operating activities:Income
      and expenses not involving cash flows:Depreciation
      and amortization
                  
                  
                  141,100
                  
                  
                  
                  153,882
                  
                  
                  
                  40,474Net
      gain from adjustment of investment  property to fair
      value
                  
                  
                  (10,456
                  )
                  
                  
                  (19,067
                  )
                  
                  
                  (5,015
                  )Share
      in (profit) loss of associates
                  
                  
                  (186
                  )
                  
                  
                  33
                  
                  
                  
                  9Share-based
      payment
                  
                  
                  -
                  
                  
                  
                  8,175
                  
                  
                  
                  2,150Loss
      (gain) from sale, disposal and impairment  of property, plant
      and equipment, net
                  
                  
                  (4,927
                  )
                  
                  
                  5,989
                  
                  
                  
                  1,575Loss
      (gain) from changes in fair value
of  derivatives
                  
                  
                  1,400
                  
                  
                  
                  (19,247
                  )
                  
                  
                  (5,062
                  )Linkage
      differences on long-term loans
      and  other  liabilities, net
                  
                  
                  18,428
                  
                  
                  
                  59,669
                  
                  
                  
                  15,694Capital
      gain on reorganized holdings in subsidiary  net of (loss) on
      decrease in the rate of holdings in  subsidiary
                  
                  
                  1,520
                  
                  
                  
                  (9,801
                  )
                  
                  
                  (2,578
                  )Increase
      (decrease) in liabilities for employee  rights,
    net
                  
                  
                  (31
                  )
                  
                  
                  263
                  
                  
                  
                  69Decrease
      in value of marketable securities, deposit and long-term receivables,
      net
                  
                  
                  54,252
                  
                  
                  
                  11,169
                  
                  
                  
                  2,938Interest
      paid, net of interest received
                  
                  
                  17,357
                  
                  
                  
                  71,466
                  
                  
                  
                  18,797Changes
      in operating assets and liabilities:Decrease
      (increase) in trade receivables and  other accounts
      receivable
                  
                  
                  (65,849
                  )
                  
                  
                  59,967
                  
                  
                  
                  15,771Increase
      in inventories
                  
                  
                  (16,145
                  )
                  
                  
                  (43,136
                  )
                  
                  
                  (11,346
                  )Increase
      in trade payables, other accounts  payable and
      provisions
                  
                  
                  27,318
                  
                  
                  
                  48,415
                  
                  
                  
                  12,735163,781
                  
                  
                  
                  327,777
                  
                  
                  
                  86,211




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


F-9





BLUE
SQUARE – ISRAEL LTD.





CONSOLIDATED
STATEMENTS OF CASH FLOWS





Conveniencetranslation(note
      2)Year
      ended
                      
                      
                      Year
      endedDecember
      31,
                      
                      
                      December
      31,2007
                      
                      
                      2008
                      
                      
                      2008NIS
                      
                      
                      U.S
      dollarsIn
      thousands(b)
                      Acquisition
      of subsidiaries:Assets
      and liabilities at date of acquisition:Working
      capital (excluding cash and cash equivalents)
                      
                      
                      (58,999
                      )
                      
                      
                      -
                      
                      
                      
                      -Property,
      plant and equipment
                      
                      
                      (31,053
                      )
                      
                      
                      -
                      
                      
                      
                      -Deferred
      taxes, net
                      
                      
                      14,703
                      
                      
                      
                      -
                      
                      
                      
                      -Liability
      for employee rights, net
                      
                      
                      1,979
                      
                      
                      
                      -
                      
                      
                      
                      -Long-term
      loans and convertible debentures
                      
                      
                      34,288
                      
                      
                      
                      -
                      
                      
                      
                      -Intangible
      assets
                      
                      
                      (176,787
                      )
                      
                      
                      -
                      
                      
                      
                      -Minority
      interest
                      
                      
                      52,483
                      
                      
                      
                      -
                      
                      
                      
                      -Derivative
                      
                      
                      1,510
                      
                      
                      
                      -
                      
                      
                      
                      -(161,876
                      )
                      
                      
                      -
                      
                      
                      
                      -(c)
                      Supplementary
      information on investing and financing activities not involving cash
      flows:Issuance
      of shares upon conversion of convertible debentures
                      
                      
                      255,676
                      
                      
                      
                      -
                      
                      
                      
                      -Conversion
      of convertible debentures of subsidiary
                      
                      
                      2,598
                      
                      
                      
                      6,655
                      
                      
                      
                      1,750Purchase
      of property, plant and equipment on credit
                      
                      
                      5,690
                      
                      
                      
                      14,797
                      
                      
                      
                      3,892





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


F-10


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE
1 - GENERAL:





Information on the activities
of Blue Square Israel Ltd and its subsidiaries





Blue
Square-Israel Ltd. ("Blue Square") is an Israeli corporation, which, directly
and through its subsidiaries (together - the Company), operates in the retail
industry. Substantially all of its activities are the operation of chains of
supermarkets in Israel. All references to the Company include, unless the
context otherwise indicates, Blue-Square and its subsidiaries. The Company
markets and sells a wide range of consumer products including food and
beverages, organic food, apparel, pharmaceuticals, housewares and cosmetics. The
Company is also engaged through its subsidiaries, in retail and wholesale
activities that are not related to the food field of operations, including
housewares, leisure and infant products. The Company is under control and
ownership of Alon Israel Oil Company Ltd.


Blue
Squareis a limited
public company incorporated and is Israeli resident. The address of its
registered office is 2 Amal St., Afek Industrial Zone, Rosh Ha’ayin,
Israel.  The shares of Blue Square are listed for trading on the
New-York Stock Exchange (the "NYSE") and on the Tel-Aviv Stock Exchange (the
"TASE").





NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:





Convenience
translation into U.S dollars (hereinafter-"dollars" or "$")





For the
convenience of the reader, the reported New Israeli Shekel (NIS) amounts as of
December 31, 2008 have been translated into dollars, at the representative rate
of exchange on December 31, 2008 (U.S. $1 = NIS 3.802). The dollar amounts
presented in these financial statements should not be construed as representing
amounts that are receivable or payable in dollars or convertible into dollars,
unless otherwise indicated.





a.
            Basis
      of presentation





1)
            Through
      December 31, 2007, the Company had drawn up its consolidated financial
      statements under accounting principles generally accepted in Israel
      (hereinafter - Israel GAAP).





Commencing
      the three-month period ended March 31, 2008, the company adopted
      IFRS.  IFRS are standards and interpretations that have been
      adopted by the International Accounting Standards Board. This body of
      standards includes:





(a)
            International
      Financial Reporting Standards
(IFRS);


(b)
            International
      Accounting Standards (IAS), and;


(c)
            Interpretations
      by the International Financial Reporting Interpretations Committee (IFRIC)
      or its predecessor, the Standing Interpretations Committee
      (SIC).





2)
            The
      Company's financial statements as of December 31, 2008 and 2007 and for
      each of the years ended on those dates have been prepared in accordance
      with IFRS.





These
      financial statements are in the scope of International Financial Reporting
      Standard No. 1 - "First-Time Adoption of International Financial Reporting
      Standards" (hereinafter - IFRS 1), because they the first annual
      financial statements of the Company that were prepared
      IFRS.  These financial statements were prepared under IFRS that
      had been issued, became effective as of December, 31,
  2008.


F-11


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





The
transition date to reporting under IFRS for the Company, under IFRS 1, is
January 1, 2007 (hereinafter - "transition date").  Comparative data
of the company as of December 31, 2007 and for the year then ended have been
restated to retrospectively reflect the adoption of IFRS as from the transition
date.  As to the effect of transition from reporting under Israeli
GAAP to reporting under IFRS on comparative data in the consolidated financial
statements, and the exemptions elected by the company under IFRS 1 - see
note 36.





The
principal accounting policies set out below have been consistently applied to
all the periods presented, unless otherwise stated.





The
consolidated financial statements have been prepared under the historical cost
convention, as modified by the revaluation of financial assets at fair value
through profit or loss, available for sale financial assets and investment
property presented at fair value and subject to the reference below to the
period during which Israel’s economy was hyper-inflationary.





The value
of non monetary assets and equity items that were measured on the basis of
historical cost under Israel GAAP, have been adjusted for changes in the general
purchasing power of the Israeli currency -NIS, based upon changes in the Israeli
Consumer Price Index (“CPI”) until December 31, 2003; as until that date the
Israeli economy was considered hyperinflational according to IFRS.





Accordingly,
amounts generating from group companies whose functional currency is the
NIS,  relating to non-monetary assets (including depreciation and
amortization thereon), investments in associated companies and equity items that
originated prior the effective date, are based on the inflation-adjusted data
(based on the December 2003 CPI), as previously reported.  All amounts
arising originated in the period subsequent to the effective date, are included
in the consolidated financial statements at their nominal values.





The
preparation of financial statements in conformity with IFRS requires the use of
certain critical accounting estimates. It also requires management to exercise
its judgment in the process of applying the group’s accounting policies. Areas
involving a higher degree of judgment or complexity, or areas where assumptions
and estimates are significant to the consolidated financial statements are
disclosed in note 4.  Actual results may differ materially from
estimates and assumptions used by the group's management.





b.
            Consolidated
      financial statements





1)        Subsidiaries





Subsidiaries
are all entities over which the Company has the power to govern the financial
and operating policies, generally accompanying shareholding of more than one
half of the voting rights. The existence and effect of potential voting rights
that are currently exercisable or convertible are considered when assessing
whether the Company controls another entity. Subsidiaries are fully consolidated
from the date on which control is obtained by the Company. They are
de-consolidated from the date that control ceases.




F-12


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):




The
purchase method of accounting is used to account for the acquisition of
subsidiaries by the Company. The cost of an acquisition is measured as the fair
value of the assets given, equity instruments issued and liabilities incurred or
assumed at the date of transaction, plus costs directly attributable to the
acquisition.  Identifiable assets acquired
and liabilities and contingent liabilities assumed in a business combination are
measured initially at their fair values at the acquisition date, irrespective of
the extent of any minority interest.  The excess of the cost of
acquisition over the fair value of the Company’s share of the identifiable net
assets acquired is recorded as goodwill (see also note 36.4).





Inter-company
transactions and balances have been eliminated in consolidation. Profit from
inter-company sales, not yet realized outside the Company, have also been
eliminated.





Accounting
policies of subsidiaries have been changed where necessary to ensure consistency
with the policies adopted by the Company.





2)        Transactions with minority
interests





The
Company accounts for transactions with minority interests as transactions with
parties external to the Company. Disposals to minority interests result in gains
and losses for the group and are recorded in the income
statement.  Purchases from minority interests result in goodwill,
being the difference between any consideration paid and the relevant share
acquired of the carrying value of net assets of the subsidiary.





A put
option granted to a minority interest is accounted for as a financial liability
based on the present value of the exercise price of the option with a
corresponding reduction of minority interest. Related finance expenses are
carried to income statements on current basis.





3)         Joint
ventures





The
Company’s interests in jointly controlled entities are accounted for by the
proportionate consolidation method.  The Company combines its share of
the joint ventures’ individual income and expenses, assets and liabilities and
cash flows on a line-by-line basis with similar items in the Company’s financial
statements.





4)     Associates





Associates
are entities over which the Company has significant influence but not control
generally accompanying between 20% and 50% of the voting rights. Investments in
associates are accounted for using the equity method of accounting and are
initially recognized at cost.





c.
            Foreign
      currency transactions





1)        Functional and presentation
currency





Items
included in the financial statements of each of the Company’s entities are
measured using the currency of the primary economic environment in which the
entity operates (the functional currency).  The consolidated financial
statements are presented in NIS, which is the Company’s functional
currency.


F-13


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





2)         Transactions and
balances





Transactions
in a currency which is different from the functional currency (foreign currency)
are translated into the functional currency using the exchange rates prevailing
at the dates of the transactions. Foreign exchange gains and losses resulting
from the settlement of such transactions and from the translation at year-end
exchange rates of monetary assets and liabilities denominated in foreign
currencies are recognized in the income statement. Foreign exchange gains and
losses are presented in the income statement within finance income or
expenses.





d.
            Property,
      plant and equipment





Property,
plant and equipment are initially recognized at acquisition
cost.  Subsequent costs are included in the asset’s carrying amount or
recognized as a separate asset, as appropriate, only when it is probable that
future economic benefits associated with the item will flow to thegroup and the
cost of the item can be measured reliably.  When part of an asset is
replaced, its carrying amount is derecognized.  All other repairs and
maintenance are charged to the income statement during the financial period in
which they are incurred.





Depreciation
and impairment charges on property, plant and equipment stated at cost are
recorded in the income statement.





Land is
not depreciated. Depreciation of other assets is calculated using the
straight-line method to allocate their cost to their residual values over their
estimated useful lives, as follows:





YearsBuildings
                
                
                50Vehicles
                
                
                5-7Furniture,
      equipment and installations
                
                3-15
      (mainly 10)





Leasehold
improvements are amortized using the straight-line method over the shorter of
the term of the lease or the expected useful lives of the
improvements.


The
assets residual values and useful lives are reviewed, and adjusted if
appropriate, at each balance sheet date.


An
assets' carrying amount is written down immediately to its recoverable amount if
the asset's carrying amount is greater than its estimated recoverable amount
(see below).





Gains and
losses on disposals are determined by comparing the proceeds with the carrying
amount and are recognized within "Other income, net" in the income
statement.





e.
            Investment
      property





Investment
property is held for long-term rental yields and is not occupied by the
Company.  Investment property is initially measured at cost, including
transaction costs.  Subsequent to initial recognition, investment
property is stated at fair value, reflecting market conditions, determined at
least annually by independent appraisers.  "O. Haushner Civil Eng.
& Real Estate Apprisal Ltd." and "Katzir Friedman Barak & Co. Economic
& Real Estate Appraisal." Fair value is based on current prices in an active
market, adjusted, if necessary, for any differences in the nature, location or
condition of the specific asset. If such information is not available, the
Company uses alternative sources such as recent prices on less active markets or
discounted cash flow projections. The fair value of the investment property is
reviewed at each balance sheet date and any changes in fair value are recorded
in the income statement under "Net gain from adjustment of investment property
to fair value".


F-14


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





Real
estate under erection  or real estate that is being developed for
future use as an investment property is classified as real estate under erection
until the investment or development  are completed and is measured at
cost. Upon change of status of real estate into investment property, the real
estate under erection is re-mesured at fair value. Any gains or losses arising
from such re-measurment are recorded in the income statement under "Net gain
from adjustment of investment property to fair value."





Revenue
from the sale of investment property, is recognized when the significant risks
and rewards of ownership of the property have been transferred to the buyer;
such revenue is not recognized where there are significant uncertainties as to
the collection of the consideration of the transaction, the costs related
thereto, or when the Company has significant continuing involvement landing the
property that was sold.





As to
amendment to IAS No.40 as part of annual improvements project of the IASB, see
bb1h) below.





f.
            Prepaid
      expenses in respect of operating
leases





Land held
under a lease with The Israel Lands Administration, when such land is not
classified and accounted for as investment property, is classified and accounted
for as an operating lease. Prepaid lease fees are included in the balance sheet
as prepaid expenses and are charged to the income statement over the term of the
lease, including any options to extend the term if it was reasonably certain,
when the lease agreement was first signed, that the Company will exercise the
option.


As to
amendment to IAS No. 17 as part of annual improvements project of the IASB, see
bb1i).





g.
            Intangible
      assets:





1)    
Goodwill





Goodwill
represents the excess of the cost of an acquisition over the fair value of the
Company’s share of the identifiable net assets of the acquired subsidiary at the
date of acquisition. Goodwill on acquisitions of subsidiaries is included in
"Intangible assets."





Goodwill
is tested annually for impairment and when circumstances indicate that the
carrying value may be impaired goodwill is carried at cost less any accumulated
impairment losses.  Impairment losses on goodwill are not
reversed.





Goodwill
is allocated to cash-generating units or groups of cash-generating units that
are expected to benefits from the business combination in which the goodwill
arose.





2)     Brand
name ,trademarks and customer base





The cost
of brand name, trademarks and customer base acquired in a business combination
is their fair value at the date of acquisition. After initial recognition, these
intangible assets which have finite useful lives are carried at cost less
accumulated amortization and any accumulated impairment losses. Amortization is
calculated using the straight-line method over their estimated useful lives
(brand name and trademarks eight years and customer base - fifteen
years).


F-15


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





3)     Computer
software





The costs
of separately acquired computer software licenses are recognized as intangible
assets. These licenses are amortized over their estimated useful lives (mainly
four years).





Costs
associated with servicing or maintaining computer software are recognized as an
expense as incurred. Costs that are directly associated with the development of
identifiable and unique software products controlled by the Company, that will
generate probable future economic benefits and that meet certain technical
financial and other criteria are recognized as intangible assets. Costs include
directly attributable employee benefits. Computer software development costs
recognized as assets are amortized over their estimated useful lives (not
exceeding four years).





Other
development expenditures that do not meet these criteria are recognized as an
expense as incurred. Development costs previously recognized as an expense are
not recognized as an asset in a subsequent period





4)    Evacuation
fees





Premiums
paid to assume existing operating lease agreements and amortized over the
remaining term of the lease.





h.
            Impairment
      of non-financial assets





The
Company reviews at each balance sheet date - whether any events have occurred or
changes in circumstances have taken place, which might indicate that there has
been impairment. When such indicators of impairment are present, the Company
evaluates whether the carrying value of the asset can be recovered, and if
necessary, records an impairment provision for the amount needed to write down
the carrying amount to the recoverable amount. In addition, assets that have an
indefinite useful life, such as goodwill, are not subject to amortization and
are tested annually for impairment.





The
recoverable amount of an asset is the higher of the asset’s fair value less
costs to sell and its value in use. Value in use is based on estimated future
cash flows from the continued use of the asset, including those expected at the
time of its future retirement and disposal discounted to their present value
using a discount rate that reflects the time value of money and the risks
specific to the asset. In determining the value in use of an asset, the Company
uses best available estimates as to the conditions that will prevail during the
remaining useful life of the asset and as to the current condition of the asset.
In computing the fair value less costs to sell of real estate, including land
and lease rights, the Company makes use of valuations prepared by
appraisers.





When it
is not possible to assess whether an impairment provision is required for an
individual asset which does not generate independent cash flows, the need for
such a provision is assessed in relation to the recoverable value of the
cash-generating unit to which that asset belongs.  For a
cash-generating unit to which goodwill has been allocated, any impairment loss
relating to that unit is initially to reduce the goodwill and the balance to
reduce the carrying amount of the other assets.


F-16


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





In 2007,
the Company evaluated impairment separately for each store as a cash-generating
unit. In 2008, the Company reorganized the food retail activities to incorporate
all activities under one subsidiary while, at the same time, organizing the
brand names so that the Company could meet the needs of specific customers in
each geographic area (promotions, prices and





variety)
and increase customer loyalty program activities. As such, in 2008 the Company
evaluates impairment separately for each store or the cash-generating unit to
which the store belongs when the cash inflows of one store are dependant on the
cash inflows of another store in the same geographic area. In evaluating
impairment, the Company considers corporate assets relating to the stores or
other cash-generating units as well as indirect costs that are directly
attributable, or that can be reasonably and consistently allocated, to the
stores or cash generating units.





An
impairment loss is recognized in the income statement under "other gain or
losses". Where events have occurred or changes in circumstances have taken place
that indicate an impairment provision previously recognized for an asset other
than goodwill may have decreased, the impairment provision may be partly or
fully reversed only if the recoverable amount of the asset has increased as a
result of changes in the estimates previously used in determining such
amount.





i.
            Borrowing
      costs





Borrowing
costs incurred in respect of the construction of any qualifying asset are
capitalized during the period of time that is required to complete and prepare
the asset for its intended use. Other borrowing costs are expensed.





j.
            Financial
      assets





1)         Classification





The
      Company classifies its financial assets in the following categories: at
      fair value through profit or loss, loans and receivables and available for
      sale. The classification depends on the purpose for which the financial
      assets were acquired. Management determines the classification of
      financial assets at initial
recognition.





a)
            Financial
      assets at fair value through profit or
loss





Financial
assets at fair value through profit or loss are financial assets held for
trading. A financial asset is classified in this category if acquired
principally for the purpose of selling in the short-term. Derivatives are also
categorized as held for trading.





b)
            Loans
      and receivables





Loans and
receivables are non-derivative financial assets with fixed or determinable
payments that are not quoted in an active market.  They are included
in current assets, except for maturities greater than 12 months after the
balance sheet date.  These are classified as non-current
assets.  The Company’s loans and receivables comprise "trade and other
receivables", "short-term bank deposit" and "cash and cash
equivalents".


F-17


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





c)
            Available-for-sale
      financial assets





Available-for-sale
financial assets are non-derivatives that are either designated in this category
or not classified to any of the other categories.  They are included
in non-current assets unless management intends to dispose of the investment
within 12 months of the balance sheet date.





2)    
Recognition and measurment





Regular
      purchases and sales of financial assets are recognized on the
      settlement-date. Investments are initially recognized at fair value plus
      transaction costs for all financial assets not carried at fair value
      through profit or loss. Financial assets carried at fair value through
      profit or loss are initially recognized at fair value and transaction
      costs are expensed in the income statement. Available-for-sale financial
      assets and financial assets at fair value through profit or loss are
      subsequently carried at fair value. Loans and receivables are carried at
      amortized cost using the effective interest
  method.





Gains
      or losses arising from changes in the fair value of the "financial assets
      at fair value through profit or loss" category are presented in the income
      statement within finance, income or expenses in the period in which they
      arise.





Gains
      or losses arising from changes in the fair value of available-for-sale
      securities are recognized in equity. Interest on non-monetary securities
      is recognized in the income statement as part of "finance income or
      expenses" using the effective interest
method.





Financial
      assets are derecognized when the rights to receive cash flows from the
      investments have expired or have been transferred and the Company has
      transferred substantially all risks and rewards of
    ownership.





When
      securities classified as available-for-sale are sold or impaired, the
      accumulated fair value adjustments recognized in equity are included in
      the income statement as part of "finance income or
    expenses".





The
      Company assesses at each balance sheet date whether there is objective
      evidence that a financial asset or a group of financial assets is
      impaired. Evidence of impairment may include indications of an event that
      has an impact on the estimated future cash flows of the financial
      asset.  In the case of equity securities classified as available
      for sale, a significant or prolonged decline in the fair value of the
      security below its cost is considered as an indicator that the securities
      are impaired. If any such evidence exists for available-for-sale financial
      assets, the cumulative loss – measured as the difference between the
      acquisition cost and the current fair value, less any impairment loss on
      that financial asset previously recognized in the income statement – is
      removed from equity and recognized in the income statement. Impairment
      losses recognized in the income statement on equity instruments are not
      reversed through the income statement; increases in fair value after
      impairments are recognized directly in
equity.


In
      the case of debt investments, if the fair value subsequently increases and
      the income can be objectively related to an event occurring after the
      impairment loss was recognized; the impairment loss is reversed through
      the income statement.


Impairment
      testing of trade receivables is described in note m
  below.


F-18


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





k.
            Derivative
      financial instruments





Derivative
financial instruments are initially recognized at fair value on the date a
derivative contract is entered into and are subsequently remeasured at their
fair value.


The
method of recognizing the resulting gain or loss depends on whether the
derivative is designated as a hedging instrument, and if so, the nature of the
item being hedged.





The
Company's derivative financial instruments do not meet the criteria required for
hedge accounting.  Changes in the fair value of these derivative
financial instruments are recognized on a current basis in the income statement
as part of "finance income or expenses."





Changes
in fair value of separable embedded derivatives are recognized in the income
statement as part of finance income or expenses.





L.
            Inventories





Inventories
(mainly merchandise) are stated at the lower of cost and net realizable
value.  Cost is determined mainly by the “first-in, first-out” (FIFO)
method. Net realizable value is the estimated selling price in the ordinary
course of business, less applicable selling expenses.





The
Company evaluates inventory shrinkage throughout the year based on the results
of periodic stock taking in its stores, and records allowances based on the
results of these counts to provide for estimated shrinkage as of balance sheet
date.





m.
            Trade
      receivables





Trade
receivables are recognized initially at fair value and subsequently measured at
amortized cost using the effective interest method, less allowance for doubtful
accounts.





Management
regularly monitors the balance of trade receivables, and the financial
statements include a specific allowance computed for accounts, the
collectability of which, in the view of management, is doubtful. The carrying
amount of the asset is reduced through the use of an allowance account and the
amount of the loss is recognized in the income statement within selling general
and administrative expenses. When a trade receivable is uncollectible, it is
written off against the allowance account. Subsequent recoveries of amounts
previously written off are credited against selling general and administrative
expenses in the income statement.





n.
            Cash
      and cash equivalents





Cash and
cash equivalents includes cash on hand, short-term bank deposits and other
short-term highly liquid investments with original maturities of three months or
less.





Bank
overdrafts are presented-within "credit and loans from banks and other" in
current liabilities in the balance sheet. For the purposes of the consolidated
statement of cash flows, cash and cash equivalents are presented net of bank
overdrafts.


F-19


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





o.
            Share
      capital





Ordinary
shares are classified as equity.





Incremental
costs directly attributable to the issue of new shares are shown in equity as a
deduction, net of tax, from issuance proceeds.





p.
            Trade
      payables and rebates





Trade
payables are recognized initially at fair value and subsequently measured at
amortized cost using the effective interest method.





Current
rebates from suppliers are recorded in the financial statements upon
receipt.





The
Company is entitled to certain rebates only upon meeting specified purchasing
targets, such as the fulfillment of a minimum annual purchase quota (in
quantitative or monetary amounts), or an increase in purchases in comparison
with purchases made in previous periods. The related rebates are recognized in
the financial statements as earned on a pro rata basis based on a systematic
calculation of the extent to which the Company has reached the
target.





In some
cases rebates due from suppliers for which the Company has no obligation to meet
specified purchasing targets, are recorded in the financial statements on the
basis of the purchases actually made.





Rebates
from suppliers are presented as a reduction of inventories and cost of sales, as
applicable.





q.
            Club
      member award and loyalty programs





Club
members participating in the Company's programs are entitled to earn benefits
upon purchasing goods, which can be utilized over a specific term to receive
certain free gifts or discounts on products or receive certain products sold by
the Company free of charge.


The
deferred revenue in respect of the said benefits is recorded as reduction of
sales when the obligation to provide those benefits is incurred. Upon exercise
of the benefits, the deferred revenue is carried to sales.





r.
            Borrowings





Borrowings
(including loans, debentures and convertible debentures) are recognized
initially at fair value, net of transaction costs
incurred.  Borrowings are subsequently stated at amortized cost; any
difference between the proceeds (net of transaction costs) and the maturity
amount is recognized in the income statement over the period of the borrowings
using the effective interest method.





For
convertible debentures, in which the conversion component constitutes an
embedded derivative (and not equity) whose economic characteristics and risks
are not closely related to the debentures, the debentures are initially
recognized as the difference between the total proceeds from issuance and the
fair value of the bifurcated embedded derivative at the date of issuance.
Subsequent to initial recognition, the embedded derivative is measured at each
balance sheet date at fair value, while the debentures are measured at amortized
cost.


F-20


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





Loans
from banks, debentures and convertible debentures, are classified as current
liabilities unless the Company has an unconditional right to defer settlement of
the liability for at least 12 months after the balance sheet date.





s.
            Current
      and deferred income taxes





The tax
expense for the period comprises current and deferred taxes. Taxes relating to
items recognized directly in equity are recognized also in equity. The current
income tax charge is calculated on the basis of the tax laws enacted or
substantively enacted at the balance sheet date. Management periodically
evaluates positions taken in tax returns with respect to situations in which
applicable tax regulations are subject to interpretation and establishes provisions
where appropriate on the basis of amounts expected to be paid to the tax
authorities.





Deferred
income tax are provided, using the liability method, on temporary differences
arising between the tax bases of assets and liabilities and their carrying
amounts in the consolidated financial statements. However, deferred income tax
is not recognized, if it arises from initial recognition of an asset or
liability in a transaction other than a business combination that at the time of
the transaction affects neither the accounting nor taxable profit. Deferred
income tax is determined using tax rates (and laws) that have been enacted or
substantially enacted by the balance sheet date and are expected to apply when
the related deferred income tax asset is realized or the deferred income tax
liability is  settled.





Deferred
income tax assets are recognized to the extent that it is probable that future
taxable profit will be available against which the temporary differences can be
utilized.





Deferred
income tax are not provided on temporary differences arising on investments in
subsidiaries, since the Company controls the timing of the reversal of the
temporary difference and it is probable that the temporary difference will not
reverse in the foreseeable future.


Deferred
tax assets and deferred tax liabilities are offset only if they relate to the
same taxable entity and that entity has a legally enforceable right to offset
those assets against the liabilities.


F-21





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES(continued):





t.
            Employee
      benefits





1)
              Retirement
      benefit obligations





The
Company operates various pension schemes.  The schemes are generally
funded through payments to insurance companies or trustee-administered funds,
determined by periodic actuarial calculations.  The Company has both
defined benefit and defined contribution plans. A defined contribution plan is a
pension plan under which the Company pays fixed contributions into a separate
entity.  The Company has no legal or constructive obligations to pay
further contributions if the fund does not hold sufficient assets to pay all
employees the benefits relating to employee service in the current and prior
periods.





Labor
laws and agreements, and the practice of the Company, require it to pay
retirement benefits to employees dismissed or retiring in certain other
circumstances.


The
obligation of the Company to pay retirement benefits is generally treated as a
defined benefit plan. However, for employees for whom the retirement benefit
obligation is covered by section 14 of the Israel Severance Pay Law , the
obligation is treated as a defined contribution plan.





As part
of the Company’s defined benefit obligation to relevant employees, the amount of
benefits that such employees are entitled to receive upon retirement is based on
the number of years of employment and the employee’s last monthly
salary.





The
Company’s obligation to the remaining employees as part of the defined
contribution plan is to make regular contributions to a separate and independent
entity, and the Company has no legal or constructive obligations to pay further
contributions if the fund does not have sufficient assets to pay all employees
the benefits relating to employee service in the current and prior
periods.





The
retirement benefit obligation recognized in the balance sheet is the present
value of the defined benefit obligation at the balance sheet date less the fair
value of plan assets. The defined benefit obligation is calculated annually by
Kost, Forer, Gabbay & Kaierer , an independent qualified actuary (hereafter
– independent qualified actuary) using the projected unit credit
method.





The
present value of the defined benefit obligation is determined by discounting the
estimated future cash outflows (after taking into account the expected rate of
salary increases and other actuarial assumptions) by reference to Israeli
Government bonds that are denominated in the currency in which the benefits will
be paid and that have terms to maturity approximating the terms of the related
pension liability.





In
accordance with IAS 19, “Employee Benefits”, the market yields used by the
Company to discount expected future cash flows are based on the interest rates
of Israeli Government bonds, since the Company’s management believes that Israel
does not have a deep market for high-quality corporate bonds.





As stated
above, the interest rate used by the Company to discount expected future cash
flows for the purpose of computing the actuarial commitment is determined based
on the interest rates of Israeli government bonds, since the Company’s
management is in the opinion that Israel does not have a deep market for
high-quality corporate bonds.


F-22


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





To the
best of Company management's knowledge, the question of whether Israel has a
deep market for corporate bonds is being considered by the Israeli Accounting
Standards Board and the Securities Authority (with the assistance of the Bank of
Israel). Should the said bodies take a position that is different than the
company's position in the matter (as presented above), the company may be
required to amend the related results it reports as part of these financial
statements.





Actuarial
gains and losses are recognized outside of profit and loss in the "statement of
recognized income and expense" (the "SORIE") in the period in which they
arise.





Amounts
funded for retirement benefits are measured at fair value. These funded amounts
represent “plan assets”, as defined by IAS 19, and therefore are offset from
retirement benefit obligation for balance sheet presentation.





The
Company purchases insurance policies and regularly contributes to
pension/retirement benefit funds to meet the pension/retirement obligation. For
defined contribution plans in which the Company has no further payment
obligations once the contributions have been paid, the contributions are
recognized as employee benefit expense when they are paid.





Prepaid
contributions are recognized as an asset to the extent that a cash refund or a
reduction in the future payments is available.





2)
            Provision
      for unutilized sick leave





Pursuant
to employment agreements, certain employees are entitled to receive payment for
a certain number of sick leave days per year which are accumulating to future
periods. Under these said agreements, the Company has undertaken to pay each
employee, upon retirement, certain amounts which depend on the balance of the
unutilized days and on the cumulative number of sick leave days the employee has
utilized during his employment with the Company.





The
provision for unutilized sick leave is based on an annual actuarial calculation
by an independent, qualified actuary: In making such a computation, the actuary
makes actuarial assumptions (rates of employee turnover, future salary levels
etc). The cost of this benefit is recognized using the same method used for
defined benefit retirement plans. Actuarial gains and losses are recognized
outside of profit or loss in the Statement of Recognized Income and Expense the
period in which they arise.





3)
            Jubilee
      grant





Pursuant
to employee agreements, certain employees are entitled to receive a jubilee
grant upon completion of service of 20, 30 and 35 years.


A
provision in respect of the jubilee grant that has been recorded in the
consolidated financial statements and is based on an annual actuarial
calculation, by an independent, qualified actuary.





4)
            Vacation
      and recreation benefits





Every
employee is legally entitled to vacation and recreation benefits, both computed
on an annual basis.  This entitlement is based on the term of
employment.  The Company records a liability and expense for vacation
and recreation pay, based on the benefits that have been accumulated for each
employee.


F-23


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





5)
            Share-based
      payment





The
Company operates an equity-settled, share-based compensation
plan.  Under this plan, the Company grant its employees stock options
at its discretion.  The fair value of the employee services received
in exchange for the grant of the options is recognized as an expense in the
income statement with a corresponding credit to accumulated deficit in equity.
The total amount to be expensed over the vesting period is determined by
reference to the fair value of the options on the date on which they are
granted. At each balance sheet date, the Company revises its estimates of the
number of options that are expected to vest. It recognizes the impact of the
revision of original estimates, if any, in the income statement, with a
corresponding adjustment to accumulated deficit in equity.





The
consideration received upon exercise of stock options, net of any directly
attributable transaction costs, are credited to share capital and additional
paid in capital.





6)
            Profit
      sharing and bonus plans





The
Company recognizes a liability and an expense for bonuses and profit-sharing for
employees, based on a formula that takes into consideration the profit
attributable to the supermarket stores after certain adjustments. The equity
holders of the Company recognizes a provision where contractually obligated or
where there is a past practice that has created a constructive
obligation.





7)
            Termination
      benefits





Termination
benefits are payable when employment is terminated by the Company before the
normal retirement date, or whenever an employee accepts voluntary redundancy in
exchange for these benefits. The Company recognizes termination benefits when it
is demonstrably committed according to a detailed formal plan without
possibility of withdrawal to either: terminating the employment of current
employees; or providing termination benefits as a result of an offer made to
encourage voluntary redundancy. Benefits falling due more than 12 months after
the balance sheet date are discounted to their present value.





u.
            Provisions





Provisions
for termination benefits cost and for legal claims are recognized when the
Company has a present legal or constructive obligation as a result of a past
event; it is probable that an outflow of resources will be required to settle
the obligation; and the amount can be reliably estimated.  Provisions
are not recognized for future operating losses.





Where
there are a number of similar obligations, the likelihood that an outflow will
be required for settlement is determined by considering the class of obligations
as a whole.  A provision is recognized even if the likelihood of an
outflow with respect to any one item in the class may be low.





Provisions
are measured at present value according to management's best estimate of the
expenditure required to settle the obligation at the balance sheet
date.


F-24


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES(continued):





v.
            Revenue
      recognition





Revenue
comprises the fair value of the consideration received or receivable for the
sale of goods - in the ordinary course of the Company’s activities. Revenue is
shown net of value added tax, returns, rebates and discounts and after
eliminating sales within the group.





When the
Company acts as an agent or an intermediary without bearing the risks and
rewards resulting from the transaction, revenues are presented on a net basis.
However, when the Company bears the risks and rewards resulting from the
transaction, revenues are presented on a gross basis, distinguishing the revenue
from the related expenses.





The
Company recognizes revenue when the amount of revenue can be reliably measured.
it is probable that future economic benefits will flow to the Company and when
specific criteria have been met for each of the Company’s activities as
described below. The amount of revenue is not considered to be reliably
measurable until all contingencies relating to the sale have been resolved. The
Company bases its estimates on past experience, taking into consideration the
type of customer, the type of transaction and the specifics of each
arrangement.





1)
            Sales
      of goods – retail





The
Company operates a chain of supermarkets that sell food products, apparel and
housewares. Sales of goods are recognized when a product is sold to the
customer. Retail sales are usually paid for in cash, checks, or by credit
cards.





It is the
Company's policy to sell products to retail customers with a right to
return.


Past
experience is used to estimate and provide an allowance for such returns at the
time the sale is recorded.





Revenue
from  the sale of gift certificates is deferred and is recognized as
income when the gift certificate is redeemed for the purchase of goods, or when
the likelihood that the customer will redeem the certificate, based on the
Company's experience, becomes remote.





Discounts,
including those related to gift certificates, are recognized as a reduction of
sales upon recognition of the related sales.





2)
            Sales
      of goods – wholesale





The
Company sells a range of products (apparel, housewares, infant products and
toys) in the wholesale market.





Sales of
goods are recognized when the products are delivered to the wholesaler. The
criteria for delivery are satisfied when the products have been shipped to the
specified location, the risks of obsolescence and loss have been transferred to
the wholesaler, and either the wholesaler has accepted the products in
accordance with the sales contract, the acceptance provisions have lapsed, or
the Company has objective evidence that all criteria for acceptance have been
satisfied.





Sales are
recorded based on the price specified in the sales contract, net of estimated
returns. No element of financing is deemed present as the sales are made under
normal credit terms, which are consistent with market
conditions.


F-25


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





3)
            Rental
      revenue





The
Company’s lease agreements are “net” lease agreements, which require the tenants
to pay all property related expenses.  The rent revenue is recognized
on a straight-line basis over the rent period.





w.
              Finance
      income and expenses





Finance
income comprises interest income on funds invested, dividend income, net gains
from changes in the fair value of financial assets measured at fair value
through profit or loss, net gain from marketable securities, foreign currency
gains, and net gains from changes in the fair value of derivative instruments
that are recognized in the income statement. Interest income is recognized as it
accrues, using the effective interest method. The net gain from changes in the
fair value of financial assets measured at fair value through profit or loss
includes interest deriving from such assets.





Finance
expense comprises interest expense on loans received and debentures issued,
changes in the time value of a discounted liability in respect of a put option
to the minority, net losses from changes in the fair value of financial assets
measured at fair value through profit or loss, foreign currency losses,
financing expenses paid under a financing lease and net losses from changes in
the fair value of derivative instruments. All borrowing costs are recognized in
the statement of income using the effective interest method.





x.
            Advertising
      costs





Advertising
costs are expensed as incurred. Reimbursements from suppliers in respect of
specific joint advertising campaigns are recognized as a reduction of these
costs, in acordance with the terms of specific agreement.





y.
            Leases





Lease
agreement in which a significant portion of the risks and rewards of ownership
are retained by the lessor are classified as operating leases. Payments made
under operating leases (net of any incentives received from the leaser) are
charged to the income statement on a straight-line basis over the period of the
lease.





Land held
under an operating lease is classified and accounted for as investment property
when the property would otherwise meet the definition of investment property. In
such case, the operating lease is accounted for as if it were a finance
lease.





z.
            Dividend
      distribution





Dividend
distribution to the Company's shareholders is recognized as a liability in the
Company’s financial statements in the period in which the dividends are approved
by the Company’s Board of Directors.





aa.
              Earnings
      per share





Basic
earnings per share are calculated by dividing the profit attributable to equity
holders of the Company by the weighted-average number of Ordinary shares
outstanding during the period.


F-26


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





Diluted
earnings per share are calculated by adjusting the profit attributable to equity
holders of the Company and the weighted-average number of outstanding Ordinary
shares for the effect of all potential Ordinary shares that are dilutive
including share options granted to employees.





bb.
              New
      and Amended IFRS and
Interpretations





New
International Financial Reporting Standards, Amendments to Standards and New
interpretations





1)
              Standards, Amendments and
      Interpretations issued but not yet
  effective:





(a)
              IAS
      27R - "Consolidated and Separate Financial Statements" (effective for
      financial years commencing on or after July 1,
  2009).


IAS 27R
requires that the effects of all transactions with non-controlling interests to
be recorded in equity if there is no change in control and accordingly, no
further goodwill or gain or loss would arise from these transactions. IAS 27R
also discusses the accounting treatment applied upon loss of control of a
subsidiary. Any retained equity interests in the investee are to be remeasured
to fair value and the resulting gain  or loss is recognized in profit
or loss. The Company will implement IAS 27R prospectively with respect to
future  transactions with non-controlling interests, commencing
January 1, 2010.





(b)
              IFRS
      3R - "Business Combinations" (effective for financial years commencing on
      or after July 1, 2009). The amended standard continues making use of the
      purchase accounting method in accounting for business combinations, but
      with several significant changes. For example, all consideration for an
      acquisition of a business would be accounted for at fair value at date of
      acquisition, inculding contingent consideration which are classified as
      liabilities that are to be subsequently remeasured through profit and
      loss. For each business combination there is an option between measuring
      the minority interest in the acquired business at fair value or based on
      the minority interest's share in the net assets of the acquired business.
      All costs attributed to the acquisition should be carried to the income
      statement. The Company will implement IFRS 3R prospectively for all
      business combinations commencing January 1,
  2010.





(c)
              IAS
      1R - "Presentation of Financial Statements" (effective for financial years
      commencing on or after January 1, 2009). IAS 1R sets overall requirements
      for the presentation of financial statements, guidelines for their
      structure and minimum requirements for their
  content.


IAS 1R
requires that any change in equity resulting from transactions with shareholders
in their capacity as owners should be presented in the statement of changes in
equity separately from changes that do not result from transactions with
shareholders (comprehensive income items). All comprehensive income items should
be presented in the statement of comprehensive income. Entities are allowed to
elect between presenting all income and expense items in a single statement of
comprehensive income or in two statements (income statements and a statement of
comprehensive income). Under IAS 1R, entities that restate or reclassify
comparative figures are required to present a restated balance sheet as of the
beginning of the earliest period presented. It is not expected that the
implementation of the IAS 1R will have a material effect on the Company's
financial statements.


F-27





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES(continued):





(d)
            IFRS
      8 – "Operating Segments" – (commencing from January 1, 2009). IFRS 8
      replaces IAS 14 "Segment Reporting". The new standard requires a
      'management approach', whereby segment information is presented on the
      same basis as that used for internal reporting purposes. The expected
      impact of IFRS 8 is still being assessed by
  management.





(e)
            Amendment
      of IAS 1 – "Presentation of Financial Statements" – (effective commencing
      from January 1, 2009. The amendment is part of the annual improvements
      project of the IASB published in May 2008. The amendment clarifies that
      only some of the financial assets and liabilities accounted for as held
      for trading in accordance with IAS 39 constitute short-term assets and
      liabilities. The Company will apply the amendment to IAS 1 commencing from
      January 1, 2009.





(f)
            Minor
      amendments were also made to the following standards: IFRS 7 – "Financial
      Instruments: Disclosures", IAS 8 – "Accounting Policy, Changes in
      Accounting Estimates and Errors", IAS 10 – "Events after the Balance
      Sheet", IAS 18 – "Revenue" and IAS 34 - "Interim Financial Reporting".
      These amendments are part of the annual improvements project of the IASB
      published in May 2008. The Company expects that these amendments will not
      have a material effect on the its financial
  statements.





(g)
            IFRIC
      13 -"Customer Loyalty Programs" - (effective from July 1, 2008). IFRIC 13
      clarifies that where goods or services are sold together with a customer
      loyalty incentive (for example, loyalty points or free products), the
      arrangement is a multiple-element arrangement and the consideration
      receivable from the customer is allocated between the components of the
      arrangement using fair values. IFRIC 13 is not expected to have a material
      effect on the Company’s financial
statements.





(h)
            IAS
      40 (Amedment), 'investment property' (hereafter - the amendment to IAS
      40), un effect commencing January 1, 2009. The amendment is part
      of  the IASB's annual improvements project published in May
      2008. property that is under construction or development for future use as
      investment property is whitin the scope of IAS 40. where the fair value
      model is applied, such property is, therefore, neasured at fair value.
      However, where fair value of investment property under construction is not
      reliably measurable, the property is measured at cost until the earlier of
      the date construction is completed and the date at which fair value
      becomes reliably measurable. The company considers the potential effect on
      the said amendment on its financial statements in the following
      periods.





(i)
            Amendment
      to International Accounting Standard No. 17 – "Leases" (hereafter "the
      amendment to IAS 17) – in effect for annual reporting periods commencing
      January 1, 2010 and thereafter).  The amendment is part of the
      annual improvements project of the IASB published in April
      2009.  In accordance with the amendment to IAS 17, the demand
      that lease of land would be classified automatically as operating lease in
      any case where it is not expected that ownership will be transferred to
      the lessee at the end of the lease period is
      cancelled.  Accordingly, the lease of land would be accounted
      for based on the regular criteria for classification as a finance lease or
      as an operating lease and based on the information available at time of
      entering into the lease agreement with retrospective application; unless
      the entity does not have the information required to apply the amendment
      to IAS 17 retrospectively.





The
Company would apply the amendment to IAS 17 commencing January 1
2010.


F-28





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES(continued):





Company's
management examines the potential effects of application of the said amendment
on its financial statements.





NOTE
3 – FINANCIAL RISK MANAGEMENT:





a.
            Financial
      risk factors





The
Company’s activities expose it to a variety of financial risks: market risk
(including currency risk, fair value interest rate risk, cash flow interest rate
risk and price risk), credit risk and liquidity risk. The Company’s overall risk
management program focuses on the unpredictability of financial markets and
seeks to minimize potential adverse effects on the Company’s financial
performance. The Company uses derivative financial instruments in order to
partially hedge certain risk exposures.





The board
of directors and senior management of the Company are responsible for
determining and supervising the financial risk management fundamentals of each
entity in accordance with each entitiy's business activities, financial
structure and the relevant market conditions.





Risk
management is carried out by the chief financial officer and treasury department
of each entity based on policies approved by the board of directors. Treasury
identifies, evaluates and hedges financial risks in close cooperation with the
Company’s operating units. The board of directors provides principles for
overall risk management, covering specific areas, such as foreign exchange risk,
interest rate risk, credit risk, use of derivative financial instruments and
non-derivative financial instruments, raising long- term debt and investment of
excess liquidity.





(a)
Market risk





(i)
Foreign currency risk





The
operating units comprising the Company are domiciled and operate in Israel. Some
of those units import part of their inventories and raw materials. Those units
are exposed to foreign currency risk arising primarily with respect to the US
dollar.  Some units use foward currency contracts in order to hedge
part of the foreign currency risk.





At  December
31 2008 and 2007, the Company did not have any substantial balances in foreign
currencies and, therefore, the Company’s exposure to foreign exchange risk was
immaterial.





(ii)
Price risk





The
Company is exposed to price risk in respect of its investments in debt
securities that are classified as available for sale or at fair value through
profit or loss. To manage its price risk arising from investments in debt
securities, the Company diversifies its portfolio in accordance with the
pre-defined limits set by the Company.





The
Company invests in Israeli Government debt securities and debt securities of
entities that are publicly traded on the Tel Aviv Stock Exchange that have a
minimum rating of A+ at the date of investment.


F-29





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3 – FINANCIAL RISK MANAGEMENT(continued):





The table
below summarizes the impact on the Company’s post-tax profit for the year and on
equity of an increase/decrease of 5% in the market price of the investments. The
analysis is based on the assumption that all other variables are held
constant.





Year ended December 31
                                                                          
                                                                          
                                                                          December 312007
                                                                          
                                                                          
                                                                          2008
                                                                          
                                                                          
                                                                          2007
                                                                          
                                                                          
                                                                          2008NIS in millionsImpact on
                                                                            post-tax profit
                                                                          
                                                                          Impact on equityGovernment
      bonds
                                                                          
                                                                          
                                                                          0.1
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          3.1
                                                                          
                                                                          
                                                                          
                                                                          2.7Corporate
      bonds
                                                                          
                                                                          
                                                                          1.1
                                                                          
                                                                          
                                                                          
                                                                          0.5
                                                                          
                                                                          
                                                                          
                                                                          3.9
                                                                          
                                                                          
                                                                          
                                                                          3.51.2
                                                                          
                                                                          
                                                                          
                                                                          0.5
                                                                          
                                                                          
                                                                          
                                                                          7.0
                                                                          
                                                                          
                                                                          
                                                                          6.2





Post-tax
profit for the year would increase/decrease as a result of gains/losses on debt
securities classified as at fair value through profit or loss. Equity would
increase/decrease as a result of gains/losses on debt securities classified as
available for sale and securities classified as fair value through profit and
loss.





Blue
Square and certain of its subsidiaries have issued convertible debentures. The
conversion components are embedded derivatives which are measured at each
reporting date at fair value. At December 31, 2008, if the market price of the
Company’s or relevant subsidiary’s shares had increased/decreased by 5% with all
other variables held constant, the effect on the fair value of the embedded
derivatives would have been increased/decreased post –tax profit for the year by
NIS 1.1 million (2007: NIS 3.9 million).





(iii) CPI
risk





The
Company has an excess of CPI- linked liabilities over CPI - linked assets
(mainly in respect of outstanding debentures). The Company uses forward CPI
contracts in order to partially hedge this risk. At December 31, 2008, if the
CPI had increased/decreased by 2% with all other variables held constant,
post-tax profit for the year would have decreased/increased by NIS 13.6 million
(2007: NIS 17.2 million).





(iv) Cash
flow and fair value interest rate risk





Borrowings
issued at variable rates expose the Company to cash flow interest rate risk.
Borrowings issued at fixed rates expose the group to fair value interest rate
risk. At December 31, 2008, if interest rates on borrowings had been 5%
higher/lower with all other variables held constant, post-tax profit for the
year would have been NIS 0.1 million (2007: NIS 0.1 million) lower/higher,
mainly as a result of higher/lower interest expense on floating rate
borrowings.  The Company’s investments in debt securities of fixed
rates and short-term deposit expose the Company to fair value interest rate
risk.  If interest rates had been 5% higher/lower with all the other
variables held constant other components of equity would have been NIS 5.7
million (2007: NIS 5.8 million) lower/higher mainly as result of the
decrease/increase in the fair value of these debt securities classified as
available for sale.


F-30





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3 – FINANCIAL RISK MANAGEMENT(continued):





(b)
Credit risk





Credit
risk is managed separately by each of the Company's operating units. Credit risk
arises from cash and cash equivalents, marketable securities, short term
deposits with banks as well as credit exposure to retail and wholesale
customers.





Cash and
cash equivalents, deposits and marketable securities are maintained with major
banking institutions in Israel.





The
Company's investments are comprised of Israeli Government debt securities and
debt securities of entities that are publicly traded on the Tel Aviv Stock
Exchange and that have a minimum rating of A+ at the date of investment.
According to the Company's investment policy, there are no significant
concentrations of credit risk in respect of investments in debt
securities.





Sales to
retail customers are collected principally through use of major credit cards,
post-dated checks (partially guaranteed by credit insurance) or
cash.





Sales to
wholesale customers are mainly made under accepted market credit terms. The
credit quality of each wholesale customer is assessed. The Company's customers
are diversified and the risk of credit concentration is immaterial. Individual
risk limits are set based on internal ratings that take into consideration the
customer’s financial position, credit history and other factors.





(c)
Liquidity risk





Prudent
liquidity risk management implies maintaining sufficient cash and marketable
securities, the availability of funding through an adequate amount of committed
credit facilities and the ability to close out market positions. Due to the
dynamic nature of the underlying businesses, the Company's operating units
maintain flexibility in funding by use of credit facilities.





Management
monitors rolling forecasts of the Company’s liquidity reserve (comprised of
borrowing facilities and cash and cash equivalents on the basis of expected cash
flows. This is generally carried out at corporate’s level. These reserves vary
by location to take into account the liquidity of the market in which the
Company operates. In addition, the Company’s
liquidity management policy involves projecting cash flows and considering the
necessary level of liquid assets; monitoring balance sheet liquidity
requirements; and maintaining debt financing plans.





The table
below analyses the Company’s financial liabilities and net-settled derivative
financial liabilities into relevant maturity groupings based on the remaining
period at the balance sheet to the contractual maturity date. The amounts
disclosed in the table are the contractual undiscounted cash
flows.  Therefore, these amounts will not reconcile to the amounts
disclosed in the balance sheet except for balances due within 12 months which
equal their carrying amounts as the impact of discounting is not
material.


F-31





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3 – FINANCIAL RISK MANAGEMENT(continued):





December 31, 2008Less than
                          1 Year
                        
                        
                        Between 1
                          and 2
                          Years
                        
                        
                        Between 2
                          and 5
                          Years
                        
                        
                        Over 5
                          Years
                        
                        
                        TotalTrade
      payables
                        
                        
                        1,004,799
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,004,799Other
      payables
                        
                        
                        435,491
                        
                        
                        
                        114
                        
                        
                        
                        499
                        
                        
                        
                        367
                        
                        
                        
                        436,471Forward
      contracts (fair value)
                        
                        
                        -
                        
                        
                        
                        11,593
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        11,593Bank
      Loans
                        
                        
                        236,163
                        
                        
                        
                        116,496
                        
                        
                        
                        214,220
                        
                        
                        
                        68,163
                        
                        
                        
                        635,042Debenture
      and convertible debentures
                        
                        
                        78,589
                        
                        
                        
                        132,231
                        
                        
                        
                        506,149
                        
                        
                        
                        812,258
                        
                        
                        
                        1,529,227Other
      long-term payables
                        
                        
                        9,130
                        
                        
                        
                        28,249
                        
                        
                        
                        15,783
                        
                        
                        
                        1,383
                        
                        
                        
                        54,545Total
                        
                        
                        1,764,172
                        
                        
                        
                        288,683
                        
                        
                        
                        736,651
                        
                        
                        
                        882,171
                        
                        
                        
                        3,671,677





December 31, 2007Less than
                        1 Year
                      
                      
                      Between 1
                        and 2
                        Years
                      
                      
                      Between 2
                        and 5
                        Years
                      
                      
                      Over 5
                        Years
                      
                      
                      TotalTrade
      payables
                      
                      
                      976,278
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      976,278Other
      payables
                      
                      
                      415,214
                      
                      
                      
                      33
                      
                      
                      
                      91
                      
                      
                      
                      46
                      
                      
                      
                      415,384Bank
      loans
                      
                      
                      199,555
                      
                      
                      
                      99,986
                      
                      
                      
                      127,877
                      
                      
                      
                      64,564
                      
                      
                      
                      491,982Debenture
      and convertible debentures
                      
                      
                      55,182
                      
                      
                      
                      72,695
                      
                      
                      
                      276,661
                      
                      
                      
                      952,380
                      
                      
                      
                      1,356,918Other
      long-term payables
                      
                      
                      7,287
                      
                      
                      
                      1,923
                      
                      
                      
                      18,749
                      
                      
                      
                      2,688
                      
                      
                      
                      30,647Total
                      
                      
                      1,653,516
                      
                      
                      
                      174,637
                      
                      
                      
                      423,378
                      
                      
                      
                      1,019,678
                      
                      
                      
                      3,271,209





b.
            Capital
      risk management





The
Company’s objectives in managing capital are to provide returns for shareholders
and benefits for other stakeholders and to maintain an optimal capital structure
to reduce the cost of capital.





In order
to maintain or adjust the capital structure, the Company may adjust the amount
of dividends paid to shareholders, return capital to shareholders, issue new
shares or sell assets to reduce debt.





Consistent
with others in the industry, the Company monitors capital on the basis of the
gearing ratio. This ratio is calculated as net debt to EBITDA. Net debt is
calculated as total borrowings (including ‘current and non-current borrowings’
as shown in the consolidated balance sheet) less cash and cash equivalents,
short-term deposits and marketable debt securities. This ratio is a non-GAAP
figure not determined in IFRS and its definition and calculation may vary from
one Company to another. The Company considers this ratio to be an impotent
measure for investors, analysts and rating agencies. The debentures of Blue
Square are rated ilA+ by S&P Maalot, see note 19b.





c.
            Fair
      value estimation





The fair
value of financial instruments traded in active markets is based on quoted
market prices at the balance sheet date.


F-32





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3 – FINANCIAL RISK MANAGEMENT(continued):





The fair
value of financial instruments that are not traded in an active market is
determined by using valuation techniques. The Company uses a variety of methods
and makes assumptions that are based on market conditions existing at each
balance sheet date. Quoted market prices or dealer quotes for similar
instruments are used for long-term debt. Other techniques, such as estimated
discounted cash flows, are used to determine fair value for the remaining
financial instruments.





The fair
value of interest rate swaps is calculated as the present value of the estimated
future cash flows. The fair value of forward foreign exchange contracts is
determined using quoted forward exchange rates at the balance sheet
date.





The
carrying value less impairment provision of trade receivables and payables and
short-term deposit, are assumed to approximate their fair values. The fair value
of financial liabilities for disclosure purposes is estimated by discounting the
future contractual cash flows at the current market interest rate that is
available to the Company for similar financial instruments.





Regarding
the fair value of non-current borrowings, see Note 19(1)(d).





d.
            Company
      exposure of monetary balances:





1.
              The
      currency exposure of the Company's monetary assets and liabilities and
      their fair value balances is as
follows:


December 31, 2008NIS linked
                                                          to CPI
                                                        
                                                        
                                                        NIS
                                                          unlinked
                                                        
                                                        
                                                        US
                                                          Dollar
                                                        
                                                        
                                                        Other
                                                          currencies
                                                        
                                                        
                                                        Total
                                                        
                                                        
                                                        Fair valueNIS in thousandsAssets:Cash
      and cash equivalents
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        95,325
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        95,325
                                                        
                                                        
                                                        
                                                        95,325Short
      term bank deposits
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        206
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        206
                                                        
                                                        
                                                        
                                                        206Marketable
      securities
                                                        
                                                        
                                                        104,803
                                                        
                                                        
                                                        
                                                        61,485
                                                        
                                                        
                                                        
                                                        4,653
                                                        
                                                        
                                                        
                                                        908
                                                        
                                                        
                                                        
                                                        171,849
                                                        
                                                        
                                                        
                                                        171,849Trade
      receivables
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        729,970
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        729,970
                                                        
                                                        
                                                        
                                                        729,970Other
      receivables
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        69,926
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        69,926
                                                        
                                                        
                                                        
                                                        69,926Income
      taxes receivable
                                                        
                                                        
                                                        74,446
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        74,446
                                                        
                                                        
                                                        
                                                        74,446Derivative
      financial instrument
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        4,700
                                                        
                                                        
                                                        
                                                        548
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        5,248
                                                        
                                                        
                                                        
                                                        5,248Long-term
      receivables
                                                        
                                                        
                                                        3,268
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        8,516
                                                        
                                                        
                                                        
                                                        8,516Total
      assets
                                                        
                                                        
                                                        182,517
                                                        
                                                        
                                                        
                                                        961,612
                                                        
                                                        
                                                        
                                                        5,201
                                                        
                                                        
                                                        
                                                        908
                                                        
                                                        
                                                        
                                                        1,155,486
                                                        
                                                        
                                                        
                                                        1,155,486Liabilities:Short-term
      bank credit and loans
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        77,988
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        77,988
                                                        
                                                        
                                                        
                                                        77,988Trade
      payables
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        1,006,053
                                                        
                                                        
                                                        
                                                        333
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        1,006,386
                                                        
                                                        
                                                        
                                                        1,006,386Other
      accounts payable and accrued expenses
                                                        
                                                        
                                                        34,437
                                                        
                                                        
                                                        
                                                        446,770
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        481,207
                                                        
                                                        
                                                        
                                                        481,207Income
      tax payables
                                                        
                                                        
                                                        6,933
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        6,933
                                                        
                                                        
                                                        
                                                        6,933Loans
                                                        
                                                        
                                                        113,880
                                                        
                                                        
                                                        
                                                        360,619
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        474,499
                                                        
                                                        
                                                        
                                                        477,750Debentures
                                                        
                                                        
                                                        985,844
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        985,844
                                                        
                                                        
                                                        
                                                        958,993Convertible
      debentures
                                                        
                                                        
                                                        156,524
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        156,524
                                                        
                                                        
                                                        
                                                        124,587Long-term
      payable
                                                        
                                                        
                                                        2,984
                                                        
                                                        
                                                        
                                                        30,633
                                                        
                                                        
                                                        
                                                        4,753
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        38,370
                                                        
                                                        
                                                        
                                                        38,304Derivative
      financial instruments
                                                        
                                                        
                                                        942
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        1,238
                                                        
                                                        
                                                        
                                                        7,301
                                                        
                                                        
                                                        
                                                        9,481
                                                        
                                                        
                                                        
                                                        9,481Total
      liabilities
                                                        
                                                        
                                                        1,301,544
                                                        
                                                        
                                                        
                                                        1,922,063
                                                        
                                                        
                                                        
                                                        6,324
                                                        
                                                        
                                                        
                                                        7,301
                                                        
                                                        
                                                        
                                                        3,237,232
                                                        
                                                        
                                                        
                                                        3,181,629


F-33





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3 – FINANCIAL RISK MANAGEMENT(continued):





2.
              Changes
      in the exchange rates of the US dollar and the Israeli CPI, in the
      reported periods are as follows:


Year
                      
                      Exchange rate of the
                        US dollar
                      
                      
                      Israel known
                        CPI (1)
                      
                      
                      Israel actual
                        CPI (2)%
                      
                      
                      %
                      
                      
                      %2008
                      
                      
                      (1.1
                      )
                      
                      
                      4.5
                      
                      
                      
                      3.82007
                      
                      
                      (9.0
                      )
                      
                      
                      2.8
                      
                      
                      
                      3.4





(1)
              Calculated
      based on published CPI date (through November of end
  year)


(2)
              Calculated
      based on actual CPI date  (through December of end
      year)





NOTE 4 - CRITICAL ACCOUNTING
ESTIMATES AND JUDGMENTS:





Estimates
and judgments are continually evaluated, and are based on historical experience
and other factors, including expectations of future events that are believed to
be reasonable under the circumstances.





Critical
accounting estimates and assumptions





The
Company makes estimates and assumptions concerning the future. The uncertainty
inherent in accounting estimates can result in outcomes that differ materially
from the estimates . The estimates and assumptions that have a significant risk
of causing a material adjustment to the carrying amounts of assets and
liabilities within the next financial year are discussed below.





1)
              Impairment
      of non financial assets





In
accordance with the accounting policy stated in note 2, the Company reviews
at each balance sheet date whether any events have occurred or changes in
circumstances have taken place, which might indicate that there has been an
impairment of property, plant and equipment and identifiable intangibles. When
such indicators of impairment are present, the Company evaluates whether the
carrying value of the asset in the Company's accounts can be recovered from the
cash flows anticipated from that asset, and, if necessary, records an impairment
provision necessary to adjust the carrying amount to the recoverable
amount.





The
recoverable amount of an asset is the higher of the net selling price of the
asset's fair value less cost to sell and its value in use. These calculations
require the use of estimates. See note 6 for details of key
assumptions.





The
Company tests at least annually whether goodwill has been impaired in accordance
with the accounting policy stated in note 2. The recoverable amount of the
cash-generating unit to which goodwill has been allocated is determined based on
value-in-use calculations. These calculations require the use of estimates. See
note 8 for details of key assumptions.





2)
            Revaluation
      of investment property





Investment
property is presented at fair value based on assessments of external independent
appraisers, who have the appropriate qualifications. In certain cases fair value
is determined using discounted cash flows that are based on assumptions as to
discount rate. Changes in the discount rate will change the calculated fair
value and may therefore materially affect the Company's results of
operations.


F-34


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4 – CRITICAL ACCOUNTING
ESTIMATES AND JUDGMENTS (continued):





3)
              Retirement
      benefit obligations and provision for unutilized sick
  leave





The
present value of the obligations depends on a number of factors that are
determined on an actuarial basis using a number of assumptions. The assumptions
used in determining the net cost of retirement benefits and provision for
unutilized sick leave include the discount rate. Other key assumptions such as
future wage increases and retirement rates, are based in part on current market
conditions and past experience. Any changes in these assumptions will impact the
carrying amount of the obligations.





The
Company determines the appropriate discount rate at the end of each
year.  This is the interest rate that should be used to determine the
present value of estimated future cash outflows expected to be required to
settle the retirement obligations. In determining the appropriate discount rate,
the Company considers the interest rates of Israeli government bonds that are
denominated in the currency in which the benefits will be paid, and that have
terms to maturity approximating the terms of the related retirement
liability.





4)
              Provisions
      for claims





The
provisions for legal claims are recorded based on the estimates of the Company’s
management (after consulting with the legal counsel) as to the likelihood that
cash flows will be required to settle these liabilities, and at the amount of
such cash flows.





5)
              Income
      taxes and deferred taxes





There are
many transactions and calculations for which the ultimate tax determination is
uncertain. The Company recognizes liabilities for anticipated tax issues based
on estimates of whether additional taxes will be due. Where the final outcome of
these matters differs from the amounts that were initially recorded, such
differences will impact the current and deferred income tax assets and
liabilities in the period in which such determination is made.





In
addition, the Company recognizes deferred tax assets and tax liabilities based
on the difference between the carrying value of such assets and liabilities and
their amount for tax purposes. The Company continually assesses the
recoverability of deferred tax assets, based on historical taxable income,
expected taxable income, the expected timing of the reversals of temporary
differences and the application of tax planning strategies. If the Company is
unable to generate sufficient future taxable income, or actual results differ
from its other assumptions, the Company might be required to reduce its deferred
tax assets or to increase its deferred tax liabilities, which will increase its
effective tax rate, and negatively affect its operations.





6)
                Impairment
      of available-for-sale financial
assets:





The
Company follows the guidance in IAS 39 to determine when an available-for-sale
financial asset is impaired.  This determination requires significant
judgment.  In making this judgment, the Company evaluates, among other
factors, the duration and extent to which the fair value of an investment is
less than its cost, and the financial position of and short-term business
outlook of the issuer of the instrument, including factors such as industry and
sector performance, changes in technology and operating and financing cash
flows.


F-35


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4 – CRITICAL ACCOUNTING
ESTIMATES AND JUDGMENTS (continued):





7)
              Fair
      value of derivative and other financial
  instruments





The fair
value of financial instruments that are not traded in an active market (for
example, derivatives) is determined by using valuation techniques. The Company
uses its judgment to select a variety of methods and make assumptions that are
mainly based on market conditions existing at each balance sheet date. The
Company has used discounted cash flow analysis for various derivative financial
assets that are not traded in active markets. Changes in assumptions could
affect the  reported fair value of these financial
instruments.





NOTE
5 - BUSINESS COMBINATIONS:





a.
            Acquisitions:





1)
            Bee
      Group Retail Ltd. ("Bee group")





a)
            In
      May 2005, the Company completed the purchase of 50% of the holding of Bee
      Group, an Israeli Company that is currently engaged in retail and
      wholesale activities in the non food area, including homewares, leisure
      and products.





Total
consideration amounted to NIS 25 million and consists of cash payment of NIS 3.2
million for the shares and NIS 21.8 million, which was granted as capital notes.
The capital notes are unlinked and interest free. The acquisition cost of Bee
Group was allocated to its assets and liabilities based on their fair value on
the date of acquisition.





The
purchase agreement stipulated that the capital notes repayment will be comprised
of distributable earnings but not in excess of 50% of such earnings and that the
other shareholders in Bee Group will be entitled consequently to a preferred
dividend in an amount equal to the notes repayment on such date, up to the full
repayment of the notes.





b)
            In
      April 2007, the Company purchased additional 10% of the issued and paid-up
      share capital of Bee Group in consideration for NIS 5 million.
      the  excess of cost over the carrying amount of the minority
      interest acquired - in the amount of NIS 1.8 million - was recorded as
      goodwill.





c)
            In
      September 2008, the Company acquired an additional 25% of the outstanding
      share capital of Bee Group, from the other shareholders of Bee Group (the
      "Sellers"), increasing the Company's interest in Bee Group to 85%. The
      Company paid NIS 35.4 million for these shares. The excess of cost over
      the carrying amount of the minority interest acquired in the amount of NIS
      29.8 million was recorded as
goodwill.





Furthermore,
during the five-year period from date of closing, the Company is entitled to
acquire the remaining 15% of Bee Group's share capital (the "Remaining Shares")
for the aggregate consideration of approximately NIS 21.24 million, increased by
7.5% annually until actual payment (the "Call Option").  At the second
anniversary of the closing date, the Sellers are entitled to sell the Remaining
Shares to the Company for the same exercise  price as for the Call
Option in the event the Company had not previously exercised the Call Option
(the "Put Option"). The agreement provides that in the event Bee Group completes
an initial public offering of its shares during the three years from date of
closing, the exercise price in the Call Option and the Put Option would
generally be adjusted in accordance with the value ascribed to the Bee Group in
the offering (including in the event the Call Option and Put Option had been
previously exercised). The put option to the minority interest is accounted for
as a financial liability based on the current redemption value of the exercise
price of the option with a corresponding reduction of minority interest and an
increase in goodwill of  NIS 17.9 million.


F-36


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 5 - BUSINESS COMBINATIONS(continued):




As a
result, as of September 2008 Bee group was fully consolidated (100%) in the
Company consolidated financial statements.





Bee Group
has paid cash dividend to Bee Group shareholders in the aggregate amount of NIS
13.7 million, of which the Sellers would be paid NIS 11 million.





2)
              Vardinon
      Textiles Ltd.("Vardinon")





In April
2007, Bee Group completed its acquisition of 85.8% of the shares conferring
ownership and control of Vardinon Textiles Ltd, an Israeli public Company which
is traded on the Tel-Aviv Stock Exchange ("TASE"). Vardinon is engaged in the
field of housewares.





The
consideration for the acquisition amounted to 38.1 million. The acquisition
generated goodwill of NIS 9.8 million, brand name of NIS 3.8 million and
customer base of NIS 0.9 million based on the purchase price
allocation.





In
December 2007, Bee Group sold approximately 1.2% of Vardinon's shares in
consideration for NIS 0.4 million, which approximated its carrying
amount.





The
financial statements of Vardinon were consolidated for the first time in 2007.
The consolidated income statements for the year 2007 include the share of
profits of Vardinon for the period from the date of acquisition to December 31,
2007.





3)
              Eden
      Briut Teva Market Ltd.
("Eden")





In
October 2007, the Company completed its acquisition of 51% of the outstanding
shares of Eden, a private Israeli retail Company established in 2003, operating
at the date of acquisition two supermarkets, specializing in organic, natural
and health food products. The consideration for the acquisition was
approximately NIS 22.5 million. In addition, the Company provided Eden with
shareholder loans in the amount of NIS 47 million of which NIS 33 million is a
long-term loan (which is treated as inter-company loan and eliminated in
consolidation). This loan is linked to the CPI and bears annual interest of
4%.  The loan would be repaid commensurate with the distribution of a
preferred dividend by Eden to the other shareholders, based on their
shareholdings in Eden. The balance of NIS 14 million is a short-term loan. The
loan bears interest of 3.15% as of December 31, 2008, which is similar to
interest payable on short-term loans of the Company. Interest is payable on a
quarterly basis. Principal is to be repaid in accordance with Eden's ability to
do so. Should the terms for grant of a bonus of $ 5 million to the CEO be met,
half of the short-term owners' loan provided by the Company would be considered
to be an owners' loan that is subject to the terms of the long-term owners'
loan, as above. Should one of the terms for a grant of bonus to the CEO, which
is the former owner of Eden, and currently holds 49% of the outstanding shares
of Eden be met, one quarter of the owners' loan provided by the Company would be
considered to be an owners' loan that is subject to the terms of the long-term
owners' loan, as above.


F-37


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 5 - BUSINESS COMBINATIONS(continued):





The
acquisition also provides for the Company to supply all guarantees and financing
required in connection with Eden's operations in the future.





The
payment of the above mention bonus to Eden's CEO is stipulated upon the
satisfaction of various operational and performance thresholds. Since Eden's CEO
is obligated to continue working in Eden, the Company makes provisions in
respect of possible future bonus payments.





The
acquisition generated goodwill of NIS 39.9 million and brand name of NIS 6.6
million based on the purchase price allocation.





The
financial statements of Eden were consolidated for the first time in 2007. The
consolidated income statement for the year 2007 includes the share of the
profits of Eden for the period from the date of acquisition to December 31,
2007.





4)
              Na’aman
      Porcelain Ltd.("Na'aman")





On
October 31, 2007, Bee Group completed the acquisition of 57.87% (51.5% on a
fully diluted basis) of the shares of Na'aman, a public Company which is traded
in the TASE. Na'aman is engaged in the field of housewares.





Total
consideration amounted to NIS 101 million (including NIS 1 million relating to
acquisition costs). The acquisition generated goodwill of NIS 55.7 million,
customer base of NIS 44.4 million and brand name of NIS 7.1 million based on the
purchase price allocation.





The
financial statements of Naaman were consolidated for the first time in 2007. The
consolidated income statement for the year 2007 includes the share in the
profits of Naaman for the period from the date of acquisition to December 31,
2007.





5)
              Blue
      Square Chain Investment Properties
("BSIP")





In
November 2008, the Company completed the cash tender offer to acquire BSIP’s
share capital for a consideration of NIS 150.7 million. Following completion of
the acquisition, the Company now holds 100% ownership and control of the shares,
and BSIP's shares will be no longer be traded in the Tel Aviv Stock Exchange. As
a result of the acquisition the Company recorded goodwill in the amount of NIS
50.6 million.





b.
            Bee
      Group Reorganization





During
2008, Bee Group reorganized its holding of the Companies in the houseware
operation.





1)
            Agreement
      for merger of  Sheshet Chain of stores for House hold utensils
      Ltd with Na'aman:





As part
of the reorganization, Na'aman issued ordinary shares to Bee Group in
consideration for its 75% holdings in Sheshet's issued share capital, and as a
result Bee Group has increased it holdings in Na'aman and decreased its holdings
in Sheshet.  Na'aman has also issued ordinary shares to the other
shareholder of Sheshet in consideration for its 25% holdings in Sheshet's issued
share capital, and as a result Bee Group decreased its holding in
Na'aman.


F-38


BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 5 - BUSINESS COMBINATIONS(continued):





As a
result of the decrease in Bee Group holdings in Na'aman, Bee group recognized a
gain of NIS 12 million, and an increase in goodwill in the amount of NIS 11.6
million. Currently, Bee Group holds 62.54% of the issued share capital of
Na'aman (59.0% on a fully diluted basis).





2)
              Agreement
      for Na'aman's acquisition of shares of
Vardinon





Na'aman
acquired all of Bee Group's holdings in Vardinon such that subsequent to the
completion of the agreement, Na'aman holds approximately 85% of Vardinon's share
capital.  The purchase price was determined based on the price paid by
the Bee Group for the acquisition of Vardinon's shares from the previous
shareholders in accordance with an agreement dated February 28, 2007, net of
adjustments as stipulated in the agreement.





c.
            Other:





1)
            As
      to a commitment of the Company in connection with acquisition of Diners
      Israel, see note 32.





2)
            The
      list of principal investee companies is presented in the appendix to the
      financial statements.





NOTE
6 – PROPERTY PLANTS AND EQUIPMENT:





a.
              Composition
      of assets and the accumulated depreciation and amortization thereon,
      grouped by major classifications, and changes therein are as
      follows:





Land and
                    buildings
                
                
                Leasehold
                    improvements
                
                
                Furniture,
                    equipment
                    and
                    installations
                
                
                Motor
                    vehicles
                
                
                TotalNIS in thousandsCost:Balance
      at January 1, 2008
                
                
                1,287,117
                
                
                
                542,236
                
                
                
                1,449,253
                
                
                
                21,480
                
                
                
                3,300,086Additions
                
                
                37,788
                
                
                
                81,301
                
                
                
                117,935
                
                
                
                3,220
                
                
                
                240,244Disposals
                
                
                -
                
                
                
                (18,906
                )
                
                
                (96,889
                )
                
                
                (2,294
                )
                
                
                (118,089
                )Transfer
      from investment property
                
                
                14,880
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                14,880Transfer
      to investment property
                
                
                (15,398
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (15,398
                )Balance
      at December 31, 2008
                
                
                1,324,387
                
                
                
                604,631
                
                
                
                1,470,299
                
                
                
                22,406
                
                
                
                3,421,723Accumulated
      depreciation:Balance
      at January 1, 2008
                
                
                278,892
                
                
                
                351,604
                
                
                
                1,016,118
                
                
                
                10,731
                
                
                
                1,657,345Additions
                
                
                20,922
                
                
                
                39,890
                
                
                
                89,107
                
                
                
                2,426
                
                
                
                152,345Disposals
                
                
                -
                
                
                
                (18,860
                )
                
                
                (95,773
                )
                
                
                (1,639
                )
                
                
                (116,272
                )Balance
      at December 31, 2008
                
                
                299,814
                
                
                
                372,634
                
                
                
                1,009,452
                
                
                
                11,518
                
                
                
                1,693,418Impairment
      of property, plant and equipment (see b below)
                
                
                9,918
                
                
                
                5,690
                
                
                
                11,475
                
                
                
                -
                
                
                
                27,083Net
      book value at December 31, 2008
                
                
                1,014,655
                
                
                
                226,307
                
                
                
                449,372
                
                
                
                10,888
                
                
                
                1,701,222





F-39





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 6 – PROPERTY PLANTS AND
EQUIPMENT(continued):





Land and
                    buildings
                
                
                Leasehold
                    improvements
                
                
                Furniture,
                    equipment
                    and
                    installations
                
                
                Motor
                    vehicles
                
                
                TotalNIS in thousandsCost:Balance
      at January 1, 2007
                
                
                1,267,831
                
                
                
                494,573
                
                
                
                1,336,437
                
                
                
                19,344
                
                
                
                3,118,185Additions
                
                
                19,286
                
                
                
                38,710
                
                
                
                116,471
                
                
                
                238
                
                
                
                174,705Disposals
                
                
                -
                
                
                
                (1,682
                )
                
                
                (18,353
                )
                
                
                (3,822
                )
                
                
                (23,857
                )Changes
      due to acquisitions of subsidiaries consolidated for the first
      time
                
                
                -
                
                
                
                10,635
                
                
                
                14,698
                
                
                
                5,720
                
                
                
                31,053Balance at December 31,
      2007
                
                
                1,287,117
                
                
                
                542,236
                
                
                
                1,449,253
                
                
                
                21,480
                
                
                
                3,300,086Accumulated
      depreciation:Balance at January 1,
      2007
                
                
                258,893
                
                
                
                321,104
                
                
                
                946,201
                
                
                
                11,814
                
                
                
                1,538,012Additions
                
                
                19,999
                
                
                
                32,000
                
                
                
                82,879
                
                
                
                2,031
                
                
                
                136,909Disposals
                
                
                -
                
                
                
                (1,500
                )
                
                
                (12,962
                )
                
                
                (3,114
                )
                
                
                (17,576
                )Balance at December 31,
      2007
                
                
                278,892
                
                
                
                351,604
                
                
                
                1,016,118
                
                
                
                10,731
                
                
                
                1,657,345Impairment
      of property, plant and  equipment (see b below)
                
                
                12,852
                
                
                
                5,614
                
                
                
                10,760
                
                
                
                -
                
                
                
                29,226Net
      book value at December 31, 2007
                
                
                995,373
                
                
                
                185,018
                
                
                
                422,375
                
                
                
                10,749
                
                
                
                1,613,515





b.
              During
      2008 the Company recorded impairment provisions resulting in net amount of
      NIS 3.4 million. This was the result of recording provisions of NIS 9.3
      million in respect of certain stores, against which was offset the
      reduction in the impairment provisions in respect of other stores that had
      been recorded in previous years in the amount of NIS 5.9
      million.





During
2007 the Company recorded a reversal of impairment provisions resulting in the
net amount of NIS 13.5 million. This was the result of recording provisions of
NIS 18.7 million for the first time in respect of certain stores, against which
was offset the reduction in the impairment provisions in respect of other stores
that had been recorded in previous years in the amount of NIS 32.2
million.





Impairment
provisions or the reversal of such provisions are included in the income
statement within Other gain or losses.





In
calculating the impairment for the reported years, based on discounted expected
future cash flows, the Company used a discount rate before tax for each
cash-generating unit (CGU) as detailed in Note 8c.





The
balance of the impairment provisions as of December 31, 2008 and 2007, is after
a reduction for depreciation corresponding to the depreciation of the related
assets and after elimination of the portion of the provision relating to assets
that were disposed of during the period.





c.
              Additional
      details:





Certain
real estate assets which have been transferred to the Company from the previous
parent cooperative are in the process of being registered in the name of the
Company.





d.
              As
      to liens placed on assets, see note
33.


F-40


BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
7 – INVESTMENT PROPERTY:
 
 The
changes in the carrying value of investment property for the years ended
December 31, 2008 and 2007, respectively, are as follows:
 
 December 312007
                          
                          
                          2008NIS in thousandsAt January
      1
                          
                          
                          298,026
                          
                          
                          
                          315,778Transfer
      to property, plant and equipment (b)
                          
                          
                          -
                          
                          
                          
                          (14,880
                          )Transfer
      from property, plant and equipment (c)
                          
                          
                          -
                          
                          
                          
                          15,398Additions
      (d)
                          
                          
                          21,339
                          
                          
                          
                          104,657Disposals
                          
                          
                          (14,978
                          )
                          
                          
                          (6,567
                          )Net
      gain from adjustments of investment property to fair value
                          
                          
                          11,391
                          
                          
                          
                          19,846At
      December 31
                          
                          
                          315,778
                          
                          
                          
                          434,232
 
 a)      All
the Company's investments are located in Israel.
 
 b)
                  In
      December 2008, the property was rented to a subsidiary and therefore it
      was transferred from investment prorperties to property, plant and
      equipment.
 
 c)
                  In
      2008, the construction of the investment property was completed and
      therefore it was transferred from property, plant and equipment to
      investment properties.
 
 d)
                  The
      additions in 2008, totaling NIS 105 million, include NIS 39 million of
      rental offices and NIS 66 million of land in areas used for commercial and
      industrial development. The additions include the completion of investment
      property transactions, the balance of which, as of December 31, 2007 (NIS
      35 million), was included in other long term
  receivables.
 
 e)
                  The
      fair value of the investment property items was determined by "O. Haushner
      Civil Eng. & Real Estate Appraisal Ltd." and "Katzir Friedman Barak
      & Co. Economic & Real Estate Appraisal", independent qualified
      appraisers who are members of the Real Estate Appraisers Association in
      Israel – based on the current prices in an active market for similar
      property, locations and conditions, and based on the discount of the cash
      flows that are expected to arise from the assets. The range of discount
      rates used by the appraiser are 8%-12% per annum (mainly
      8-8.75%).
 
 f)
                  Rental
      revenue that has been recognized in the income statement within
      sales:
 
 Year ended December 31,2007
                          
                          
                          2008NIS in thousandsRental income
                          
                          
                          15,772
                          
                          
                          
                          20,152
 
 F-41
 
 BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
8 – INTANGIBLE ASSETS:
 
 a.
                  Composition
      of intangible assets and the accumulated amortization thereon, grouped by
      major classifications, and changes therein in 2007 and 2008, are as
      follows:
 Brandname
      andtrade
                                                                                                                          
                                                                                                                          
                                                                                                                          Customer
                                                                                                                          
                                                                                                                          
                                                                                                                          EvacuationGoodwill
                                                                                                                          
                                                                                                                          
                                                                                                                          Software
                                                                                                                          
                                                                                                                          
                                                                                                                          marks
                                                                                                                          
                                                                                                                          
                                                                                                                          base
                                                                                                                          
                                                                                                                          
                                                                                                                          fees
                                                                                                                          
                                                                                                                          
                                                                                                                          TotalNIS
      in thousandsBalance
      at January 1, 2007Cost
                                                                                                                          
                                                                                                                          
                                                                                                                          81,110
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          60,518
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          2,926
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          215
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          1,230
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          145,999Accumulated
      amortization and impairment
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (45,273
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (954
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (20
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (46,247
                                                                                                                          )Net
      carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          81,110
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          15,245
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          1,972
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          195
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          1,230
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          99,752Year
      ended 31 December 2007Opening
      net carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          81,110
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          15,245
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          1,972
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          195
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          1,230
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          99,752Additions
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          10,320
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          58
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          4,643
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          15,021Decrease
      in ownership interest in subsidiary due to dilution
                                                                                                                          
                                                                                                                          
                                                                                                                          (2,051
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (2,051
                                                                                                                          )Changes
      due to acquisitions of subsidiaries consolidated for the first
      time
                                                                                                                          
                                                                                                                          
                                                                                                                          111,356
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          17,631
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          45,408
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          2,392
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          176,787Amortization
      charge
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (6,427
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (797
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (605
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (1,260
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (9,089
                                                                                                                          )Closing
      net carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          190,415
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          19,138
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          18,864
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          44,998
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          7,005
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          280,420At
      31 December 2007Cost
                                                                                                                          
                                                                                                                          
                                                                                                                          190,415
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          70,838
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          20,615
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          45,623
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          8,265
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          335,756Accumulated
      amortization and impairment
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (51,700
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (1,751
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (625
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (1,260
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          55,336Net
      carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          190,415
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          19,138
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          18,864
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          44,998
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          7,005
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          280,420Year
      ended 31 December 2008Opening
      net carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          190,415
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          19,138
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          18,864
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          44,998
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          7,005
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          280,420Changes
      due to acquisitions of minority interest
                                                                                                                          
                                                                                                                          
                                                                                                                          111,890
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          111,890Additions
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          19,299
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          122
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          11,311
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          30,372Decrease
      in ownership interest in subsidiary due to dilution
                                                                                                                          
                                                                                                                          
                                                                                                                          (2,467
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (447
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (2,914
                                                                                                                          )Amortization
      charge
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (8,493
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (1,925
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (3,207
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (2,081
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (15,706
                                                                                                                          )Closing
      net carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          299,838
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          29,944
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          17,061
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          41,791
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          15,788
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          404,422At
      31 December 2008Cost
                                                                                                                          
                                                                                                                          
                                                                                                                          299,838
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          90,137
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          20,737
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          45,623
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          19,129
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          475,464Accumulated
      amortization and impairment
                                                                                                                          
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          (60,193
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (3,676
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (3,832
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (3,341
                                                                                                                          )
                                                                                                                          
                                                                                                                          
                                                                                                                          (71,042
                                                                                                                          )Net
      carrying amount
                                                                                                                          
                                                                                                                          
                                                                                                                          299,838
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          29,944
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          17,061
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          41,791
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          15,788
                                                                                                                          
                                                                                                                          
                                                                                                                          
                                                                                                                          404,422
  F-42
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 8 - INTANGIBLE ASSETS(continued):
 
 b.
                  Amortization
      of NIS 15.7 million (2007: NIS 9 million) is included in the income
      statement within Selling, general and administrative
    expenses.
 
 c.
                  Impairment
      tests for goodwill
 
 Goodwill
is allocated to three identified groups of cash-generating units
(CGUs).
 
 The
components of goodwill are as follows:
 
 December 31,2007
                        
                        
                        2008NIS in thousandsFood
      Retail
                        
                        
                        110,120
                        
                        
                        
                        162,780Houseware
                        
                        
                        69,419
                        
                        
                        
                        110,952Leisure
                        
                        
                        10,876
                        
                        
                        
                        26,106190,415
                        
                        
                        
                        299,838
 
 The
recoverable amount of a CGU is determined based on value-in-use calculations.
These calculations use pre-tax cash flow projections based on financial budgets
approved by management and management estimation covering a five-year period.
Cash flows beyond the five-year period are extrapolated using the estimated
growth rates stated below. The growth rate does not exceed the long-term average
growth rate for the business in which the CGU operates.
 
 The key
assumptions used for value in-use calculations are as follows:
 
 Food
      retail
                          
                          
                          Houseware
                          
                          
                          Leisure%Gross
      margin (1)
                          
                          
                          26.5
                          
                          
                          
                          20.6
                          
                          
                          
                          33-59Growth
      rate (2)
                          
                          
                          2
                          
                          
                          
                          2
                          
                          
                          
                          2Discount
      rate (3)
                          
                          
                          10
                          
                          
                          
                          14.6
                          
                          
                          
                          14-18.25
 1.
                  Expected
      gross margin.
 2.
                  Weighted
      average growth rate used to extrapolate cash flows beyond the budget
      management estimations covering a five-year
  period.
 3.
                  Pre-tax
      discount rate applied to cash flow
projections.
 
 These
assumptions have been used for the analysis of each CGU.
 
 Management
determined budgeted gross margin based on past performance and its expectations
of market development. The weighted average growth rates used are consistent
with the forecasts included in industry reports. The discount rates used are
pre-tax and reflect specific risks relating to the relevant operating business
unit.
 
 F-43
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
9 – INVESTMENTS IN JOINT VENTURES AND ASSOCIATES:
 
 a.
Investment in joint ventures
 
 The
      following amounts represent the group 50% share of the assets and
      liabilities, and the results of these companies (the identity of these
      companies are listed in the appendix at the end of the financial
      statements).
 
 December 312007
                      
                      
                      2008NIS in thousandsAssets:Current
      assets
                      
                      
                      3,729
                      
                      
                      
                      3,226Non
      current assets
                      
                      
                      48,726
                      
                      
                      
                      51,22152,455
                      
                      
                      
                      54,447Liabilities:Current
      liabilities
                      
                      
                      2,251
                      
                      
                      
                      2,327Non
      current liabilities
                      
                      
                      3,303
                      
                      
                      
                      9,6635,554
                      
                      
                      
                      11,990Net
      Assets:
                      
                      
                      46,901
                      
                      
                      
                      42,457
 
  ́
                      December 312007
                      
                      
                      2008NIS in thousandsSales
                      
                      
                      2,041
                      
                      
                      
                      3,916Expenses
                      
                      
                      1,276
                      
                      
                      
                      1,128Profit
      for the year
                      
                      
                      2,245
                      
                      
                      
                      3,094
 
 b.       Investment
in associates
 
 1. Composition
 December
      31,2007
                            
                            
                            2008NIS
      in thousandsShares:Cost
      of shares
                            
                            
                            402
                            
                            
                            
                            402Share
      in undistributed profits accumulated since acquisition
                            
                            
                            2,452
                            
                            
                            
                            2,4192,854
                            
                            
                            
                            2,821Perpetual
      capital notes (a)
                            
                            
                            1,378
                            
                            
                            
                            1,378Long-term
      loans (b)
                            
                            
                            716
                            
                            
                            
                            7164,948
                            
                            
                            
                            4,915
 
 (a)
                    Perpetual
      capital notes are linked to the Israeli CPI and bear interest at an annual
      rate of 5%.
                      The
      interest and difference of linkage to the CPI are paid on annual
      bases.
 (b)
                    The
      loans are linked to the Israeli CPI and bear interest at an annual rate of
      4.5%. The repayment date has not yet been determined.
                      The
      interest and difference of linkage to the CPI are paid on annual
      bases.
  F-44
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 9 – INVESTMENTS IN JOINT
VENTURES AND ASSOCIATES(continued):
 
 2.
                  The
      Company share of the results of its principal associates, all of which are
      unlisted, and its aggregated assets (including goodwill) and liabilities,
      are as follows:
 
 Name
                      
                      Assets
                      
                      
                      Liabilities
                      
                      
                      Revenues
                      
                      
                      Profit (loss)
                      
                      
                      % interest
                          heldNIS in thousands2008Radio
      "Non-stop" Ltd
                      
                      
                      7,157
                      
                      
                      
                      4,802
                      
                      
                      
                      7,362
                      
                      
                      
                      (33
                      )
                      
                      
                      33
                      %"Tush
      Hafakot" Ltd
                      
                      
                      230
                      
                      
                      
                      304
                      
                      
                      
                      548
                      
                      
                      
                      -
                      
                      
                      
                      25
                      %2007Radio  "Non-stop”
      Ltd
                      
                      
                      6,804
                      
                      
                      
                      4,275
                      
                      
                      
                      6,668
                      
                      
                      
                      199
                      
                      
                      
                      33
                      %"Tush
      Hafakot" Ltd
                      
                      
                      18
                      
                      
                      
                      235
                      
                      
                      
                      472
                      
                      
                      
                      (13
                      )
                      
                      
                      25
                      %
 
 NOTE 10a - FINANCIAL INSTRUMENTS BY
CATEGORY:
 
 December 31, 2008Loans and
                          Receivables
                      
                      
                      Assets at
                          fair value
                          through the
                          profit and
                          loss
                      
                      
                      Available
                          for sale
                      
                      
                      TotalNIS in thousandsCash and cash equivalents
                      
                      
                      95,325
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      95,325Short
      term bank deposits
                      
                      
                      206
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      206Marketable
      securities
                      
                      
                      -
                      
                      
                      
                      14,713
                      
                      
                      
                      157,136
                      
                      
                      
                      171,849Trade
      receivables
                      
                      
                      729,970
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      729,970Other
      receivables excluding prepayments
                      
                      
                      69,926
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      69,926Income
      taxes receivable
                      
                      
                      74,446
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      74,446Investment
      in associates
                      
                      
                      2,180
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,180Long-term
      receivables
                      
                      
                      1,088
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,088Derivative
      financial instruments
                      
                      
                      -
                      
                      
                      
                      5,248
                      
                      
                      
                      -
                      
                      
                      
                      5,248Total
                      
                      
                      973,141
                      
                      
                      
                      19,961
                      
                      
                      
                      157,136
                      
                      
                      
                      1,150,288
 
 December 31, 2008Other
                          financial
                          liabilities at
                          amortized
                          cost
                      
                      
                      Liabilities at
                          fair value
                          through the
                          profit and
                          loss
                      
                      
                      TotalNIS in thousandsShort-term
      bank credit and loans
                      
                      
                      77,988
                      
                      
                      
                      -
                      
                      
                      
                      77,988Trade
      payable
                      
                      
                      1,006,386
                      
                      
                      
                      -
                      
                      
                      
                      1,006,386Other
      account payable
                      
                      
                      426,217
                      
                      
                      
                      -
                      
                      
                      
                      426,217Derivative
      financial instrument (included among other accounts
    payable)
                      
                      
                      -
                      
                      
                      
                      11,593
                      
                      
                      
                      11,593Income
      tax payable
                      
                      
                      6,933
                      
                      
                      
                      -
                      
                      
                      
                      6,933Provisions
                      
                      
                      43,397
                      
                      
                      
                      -
                      
                      
                      
                      43,397Bank
      loans
                      
                      
                      474,499
                      
                      
                      
                      
                      
                      
                      
                      474,499Convertible
      debentures
                      
                      
                      148,549
                      
                      
                      
                      -
                      
                      
                      
                      148,549Conversion
      component embedded in the convertible debentures
                      
                      
                      -
                      
                      
                      
                      7,975
                      
                      
                      
                      7,975Debentures
                      
                      
                      985,844
                      
                      
                      
                      -
                      
                      
                      
                      985,844Derivative
      financial instruments
                      
                      
                      -
                      
                      
                      
                      9,481
                      
                      
                      
                      9,481Long-term
      payable
                      
                      
                      38,370
                      
                      
                      
                      -
                      
                      
                      
                      38,370Total
                      
                      
                      3,208,183
                      
                      
                      
                      29,049
                      
                      
                      
                      3,237,232
  F-45
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 10a - FINANCIAL INSTRUMENTTS BY
CATEGORY (continued):
 
 December 31, 2007Loans and
                          Receivables
                      
                      
                      Assets at
                          fair value
                          through the
                          profit and loss
                      
                      
                      Available
                          for sale
                      
                      
                      TotalNIS in thousandsCash and cash equivalents
                      
                      
                      56,410
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      56,410Short
      term bank deposits
                      
                      
                      103,498
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      103,498Marketable
      securities
                      
                      
                      -
                      
                      
                      
                      32,795
                      
                      
                      
                      166,599
                      
                      
                      
                      199,394Trade
      receivables
                      
                      
                      776,251
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      776,251Other
      receivables excluding prepayments
                      
                      
                      81,910
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      81,910Income
      taxes receivable
                      
                      
                      23,062
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      23,062Investment
      in associates
                      
                      
                      2,094
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,094Long-term
      receivables
                      
                      
                      2,430
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,430Derivative
      financial instruments
                      
                      
                      -
                      
                      
                      
                      10,500
                      
                      
                      
                      -
                      
                      
                      
                      10,500Total
                      
                      
                      1,045,655
                      
                      
                      
                      43,295
                      
                      
                      
                      166,599
                      
                      
                      
                      1,255,549
 
 December 31, 2007Other
                          financial
                          liabilities at
                          amortized
                          cost
                      
                      
                      Liabilities at
                          fair value
                          through the
                          profit and
                          loss
                      
                      
                      TotalNIS in thousandsShort-term
      bank credit and loans
                      
                      
                      53,749
                      
                      
                      
                      -
                      
                      
                      
                      53,749Trade
      payable
                      
                      
                      981,188
                      
                      
                      
                      -
                      
                      
                      
                      981,188Other
      account payable
                      
                      
                      404,929
                      
                      
                      
                      -
                      
                      
                      
                      404,929Income
      tax payable
                      
                      
                      2,905
                      
                      
                      
                      -
                      
                      
                      
                      2,905Provisions
                      
                      
                      35,073
                      
                      
                      
                      -
                      
                      
                      
                      35,073Bank
      loans
                      
                      
                      365,749
                      
                      
                      
                      -
                      
                      
                      
                      365,749Convertible
      debentures
                      
                      
                      147,566
                      
                      
                      
                      -
                      
                      
                      
                      147,566Conversion
      component embedded in the convertible debentures
                      
                      
                      -
                      
                      
                      
                      46,140
                      
                      
                      
                      46,140Debentures
                      
                      
                      818,877
                      
                      
                      
                      -
                      
                      
                      
                      818,877Derivative
      financial instruments
                      
                      
                      -
                      
                      
                      
                      9,968
                      
                      
                      
                      9,968Long-term
      payable
                      
                      
                      11,646
                      
                      
                      
                      -
                      
                      
                      
                      11,646Total
                      
                      
                      2,821,682
                      
                      
                      
                      56,108
                      
                      
                      
                      2,877,790
 
 F-46
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
10b – CREDIT QUALITY OF FINANCIAL ASSETS:
 
 The
credit quality of financial assets that are neither past due nor impaired can be
assessed by reference to the internal composition based on historical
information that has been accumulated in the Company's entities over the years,
as follows:
 
 December
      312007
                      
                      
                      2008NIS
      in thousandsTrade
      receivablesBalances
      with related party (note 34)
                      
                      
                      42,771
                      
                      
                      
                      56,550Credit
      cards
                      
                      
                      550,159
                      
                      
                      
                      482,345Insured
      checks receivables*
                      
                      
                      479
                      
                      
                      
                      40,091Checks
      receivables
                      
                      
                      106,261
                      
                      
                      
                      81,935Open
      accounts
                      
                      
                      56,761
                      
                      
                      
                      48,663756,431
                      
                      
                      
                      709,584
 
 *
                  The
      Company and part of the Company's subsidiaries are engaged with check
      credit companies to fully receive payments of checks that have been
      approved by the check credit company, even if no cover is available at the
      indicated time of payment.
 
 Cash
and cash equivalents and short term bank deposit
 
 Most of
the Company Cash and cash equivalents and short term deposit at December 31,
2008 were deposited with major bank in Israel.
 
 Available-for-sale
debt securities
 
 As
described in note 3, the Company's investments are publicly traded in the
Tel-Aviv Stock Exchange and independently rated with a minimum A+ at the date of
investment.
 
 The
balances are presented at fair value net of provision for impairments that were
from equity into income statements.
 
 The
maximum exposure to credit risk at the reporting date is the carrying value of
the financial assets presented in the balance sheet.
 
 F-47
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
11 – MARKETABLE SECURITIES:
 
 December
      312007
                        
                        
                        2008NIS
      in thousandsAvailable
      for sale financial assets
                        
                        
                        166,599
                        
                        
                        
                        157,136Financial
      assets at fair value through profit or loss
                        
                        
                        32,795
                        
                        
                        
                        14,713199,394
                        
                        
                        
                        171,849
 
 a.
                  Available
      for sale financial assets
 
 2007
                      
                      
                      2008NIS in thousandsAt
      January 1
                      
                      
                      -
                      
                      
                      
                      166,599Additions
                      
                      
                      175,258
                      
                      
                      
                      169,747Disposales
                      
                      
                      (13,340
                      )
                      
                      
                      (185,104
                      )Net
      gain
                      
                      
                      4,681
                      
                      
                      
                      5,894At
      December 31
                      
                      
                      166,599
                      
                      
                      
                      157,136
 
 In 2008
the Company removed profits in the amount of NIS 3,810 from equity into the
income statement. In addition, the Company classified NIS 2,503 to equity due to
impairments.
 
 Available-for-sale
financial assets includes the following:
 
 December 312007
                      
                      
                      2008NIS in thousandsGovernment
      Bonds
                      
                      
                      84,500
                      
                      
                      
                      74,034Corporate
      Bonds
                      
                      
                      82,099
                      
                      
                      
                      83,102166,599
                      
                      
                      
                      157,136
 
 Available-for-sale
financial assets are denominated in the following currencies:
 
 December 312007
                      
                      
                      2008NIS in thousandsNIS -
      Unlinked
                      
                      
                      54,757
                      
                      
                      
                      61,484NIS
      linked to the Israeli CPI
                      
                      
                      108,410
                      
                      
                      
                      90,090Other
      foreign currencies
                      
                      
                      3,432
                      
                      
                      
                      5,562166,599
                      
                      
                      
                      157,136
 F-48
 
 BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
11 – MARKETABLE SECURITIES (continued):
 
 b.
                  Financial
      assets at fair value through profit or
loss
 
 
 December
      312007
                      
                      
                      2008NIS
      in thousandsGovernment
      bonds
                      
                      
                      2,638
                      
                      
                      
                      -Corporate
      bonds
                      
                      
                      30,157
                      
                      
                      
                      14,713Total
                      
                      
                      32,795
                      
                      
                      
                      14,713
 
 The fair
value of all debt securities is based on closing prices in an active
market.
 
 NOTE
12 – DERIVATIVE FINANCIAL INSTRUMENTS:
 
 December
      312007
                          
                          
                          2008Derivative
      financial
                            instruments
                          Balance
      sheet
                            item
                          
                          NIS
      in thousandsAssets
                          
                          
                          Liabilities
                          
                          
                          Assets
                          
                          
                          LiabilitiesForward
      contracts over the
                            Israeli
      CPI*
                          Other
      payables
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          11,593Embedded
      derivatives :Rent
      agreements
                          Derivatives
      financial instruments
                          
                          
                          -
                          
                          
                          
                          8,458
                          
                          
                          
                          548
                          
                          
                          
                          8,539Conversion
      component embedded in the convertibledebentures
      (see note 19)
                          Convertible
      debentures
                          
                          
                          -
                          
                          
                          
                          46,140
                          
                          
                          
                          -
                          
                          
                          
                          ** 7,975Diners
      option (see note 32)
                          Derivatives
      financial instruments
                          
                          
                          10,500
                          
                          
                          
                          -
                          
                          
                          
                          4,700
                          
                          
                          
                          -Warrants
                          Derivatives
      financial instruments
                          
                          
                          -
                          
                          
                          
                          1,510
                          
                          
                          
                          -
                          
                          
                          
                          942Total
                          
                          
                          
                          10,500
                          
                          
                          
                          56,108
                          
                          
                          
                          5,248
                          
                          
                          
                          29,049
 
 *
                    The
      notional principal amounts of the outstanding forward over the Israeli CPI
      contracts at  December 31,2008 were NIS 351,000
      thousands.
 **
                  The
      amount of NIS 7,645 is shown with the current maturities of the
      convertible debentures.
 
 F-49
 
 BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
13 – TRADE RECEIVABLES AND OTHER RECEIVABLES:
 
 a.       Trade
receivables
 
 December
      312007
                      
                      
                      2008NIS
      in thousandsTrade
      receivables (see note 10b)
                      
                      
                      810,786
                      
                      
                      
                      767,548Less:
      provision for impairment of trade receivables
                      
                      
                      (34,535
                      )
                      
                      
                      (37,578
                      )776,251
                      
                      
                      
                      729,970
 
 As of
December 31, 2008, trade receivables of  NIS 11,165 (2007: NIS 7,894)
were past due but not impaired. These relate to a number of independent
customers for whom there is no recent history of default. The ageing analysis of
these trade receivables is as follows:
 
 December
      312007
                          
                          
                          2008NIS
      in thousandsUp
      to 3 months
                          
                          
                          3,268
                          
                          
                          
                          3,1993
      to 6 months
                          
                          
                          4,626
                          
                          
                          
                          7,9667,894
                          
                          
                          
                          11,165
 
 As of
December 31, 2008, trade receivables of NIS 46,799 (2007: NIS 46,461) were
impaired and provided for. The amount of the provision was NIS 37,578 as of
December 31, 2008 (2007: NIS 34,535). The individually impaired receivables
mainly relate to individual customers, which have unexpectedly encountered
difficult situations. It was assessed that a portion of the receivables is
expected to be recovered. The ageing of these receivables is over 6
months.
 
 Movements
in the Company's provisions for impairment of trade receivables are as
follows:
 
 2007
                      
                      
                      2008NIS
      in thousandsAt
      January 1
                      
                      
                      29,945
                      
                      
                      
                      34,535Provisions
      for receivables impairment
                      
                      
                      3,920
                      
                      
                      
                      4,667Receivables
      written off during the year as uncollectible
                      
                      
                      (1,062
                      )
                      
                      
                      (1,354
                      )Unused
      amounts reversed
                      
                      
                      (225
                      )
                      
                      
                      (270
                      )Additions
      in respect of companies consolidated for thefirst
      time
                      
                      
                      1,957
                      
                      
                      
                      -At
      December 31
                      
                      
                      34,535
                      
                      
                      
                      37,578
 
 The
creation and release of provisions for impaired receivables have been included
in the income statement within "Selling, general and administrative
expenses."  Amounts charged to the allowance account are generally
written off when there is no expectation of recovering additional
cash.
 
 The
maximum exposure to credit risk at the reporting date is the carrying value of
each class of receivables mentioned above. The Company does not hold any
collateral as security.
 
 The fair
value of trade receivables is usually identical or close to their carrying
value.
  F-50
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 13 – TRADE RECEIVABLES AND OTHER
RECEIVABLES (continued):
  December
      312007
                        
                        
                        2008NIS
      in thousandsb.           Other
      receivablesPrepayments
                        
                        
                        17,931
                        
                        
                        
                        17,698Related
      parties
                        
                        
                        20,378
                        
                        
                        
                        8,104Government
      authorities
                        
                        
                        -
                        
                        
                        
                        7,772Receivables
      in respect of gift certificates
                        
                        
                        32,477
                        
                        
                        
                        20,388Other
                        
                        
                        29,055
                        
                        
                        
                        33,66299,841
                        
                        
                        
                        87,624
  The fair
value of other receivables is usually identical or close to their carrying
value.
 
 c.      Other
long term receivables
 December
      312007
                        
                        
                        2008NIS
      in thousandsPayments
      on account of real estate (1)
                        
                        
                        45,825
                        
                        
                        
                        -Others
                        
                        
                        2,464
                        
                        
                        
                        1,55448,289
                        
                        
                        
                        1,554
 
 (1)
                  In
      November 2007, BSRE's audit committee and Board of Directors approved the
      founders’ agreement (hereinafter – "the founders agreement"), which BSRE
      signed with Bee Group. Under the said agreement, BSRE and Bee Group would
      establish a joint Company (hereinafter – "the joint Company") in equal
      parts for the purpose of acquiring land in the Beer Tovia industrial zone;
      this land would be used for the erection of a logistic centre, of 20,000
      square meters, to be used mainly by Bee Group (hereinafter – "the
      project").  On the same date, the audit committee and the Board
      of Directors also approved the agreement BSRE signed, in the name of the
      joint Company, with a third party, for the acquisition of the land as
      above, at the area of 74 dunam and in consideration for NIS 18
      million.
 
 The joint
Company "Logistic Center Bee Blue Square Ltd." was established on January 2,
2008. The rental agreements and terms thereof were approved by BSRE's general
assembly on January 6, 2008. As of December 31, 2007 BSRE and Bee Group paid an
advance of NIS 12 million. As of December 31,2008 the balance is included in the
property, plant and equipment.
 
 In
December 2008, after the BSRE'S Audit Committee has given its approval, the
Board of Directors allowed the company to acquire from Bee Group its holdings in
Logistic Center Bee Blue Square Ltd. and its rights (arising from a
shareholders' loan extended to Logistic Center Bee Blue Square Ltd. in
consideration for NIS 50 thousands for the share and an amount equal to the
balance of the shareholders' loan extended by Bee Group Retail Ltd. to Logistic
Center Bee Blue Square Ltd. (as of December 31, 2008 – the balance of the loans
was NIS 9,388 thousands), so that after the said transactions the company would
hold 100% of the share capital and voting rights in Logistic Center Bee Blue
Square Ltd. and in the shareholders' loans that were approved.
 
 In
November 2007, BSRE has entered into agreements with third parties in connection
with the acquisition of an industrial asset in Kiriat Arieh in Petah Tikvah
(hereinafter – "the asset"), in consideration for NIS 31 million (hereinafter –
"the consideration").
  F-51
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 13 – TRADE RECEIVABLES AND OTHER
RECEIVABLES (continued):
 
 Upon
signing the agreement, BSRE advanced a total of NIS 12.5 million on account of
the consideration. BSRE paid the remaining amount of consideration – NIS 18.5
million on January 1, 2008 against transfer of possession. As of December
31,2008 the balance is included in investment property.
 
 On
December 31, 2007 BSRE entered into an agreement with a third party for the
acquisition of land of 11 dunam, located on Weitzman St. in the Ra’anana North
industrial zone (hereinafter – the land) in consideration for NIS 33.5 million
(hereinafter – the consideration). BSRE paid an advance of NIS 21.5 million at
the date of the agreement. On January 14, 2008, BSRE paid the remaining
consideration for the land – NIS 12 million and was given possession of the
land. As of December 31,2008 the balance is included in investment
property.
 
 NOTE
14 – CASH AND CASH EQUIVALENTS:
 Weighted average
                              
                              
                              December 31Interest rates at
                              
                              
                              2007
                              
                              
                              2008December 2008
                              
                              
                              NIS in thousandsCash at bank and
      on hand
                              
                              
                              
                              
                              
                              17,978
                              
                              
                              
                              14,149Short-term
      bank deposits
                              
                              
                              2.84%
                              
                              
                              
                              38,432
                              
                              
                              
                              81,17656,410
                              
                              
                              
                              95,325
 
 Cash,
cash equivalents and bank overdrafts include the following for the purposes of
the
 cash flow
statement:
 
 December
      312007
                      
                      
                      2008NIS
      in thousandsCash
      and cash equivalents
                      
                      
                      56,410
                      
                      
                      
                      95,325Bank
      overdrafts (note 19(1))
                      
                      
                      (3,381
                      )
                      
                      
                      (12,187
                      )53,029
                      
                      
                      
                      83,138
 
 NOTE
15 – SHARE CAPITAL AND PREMIUM:
  AdditionalOrdinary
                          
                          
                          paid-inNumber of
                          
                          
                          shares
                          
                          
                          capital
                          
                          
                          Totalshares
                          
                          
                          NIS in thousandsAt January 1, 2007
                          
                          
                          39,692,983
                          
                          
                          
                          53,414
                          
                          
                          
                          766,409
                          
                          
                          
                          819,823Change
      during 2007 -Issuance
      of shares upon conversion of convertible debentures
                          
                          
                          3,679,836
                          
                          
                          
                          3,680
                          
                          
                          
                          251,996
                          
                          
                          
                          255,676At
      December 31, 2007
                          
                          
                          43,372,819
                          
                          
                          
                          57,094
                          
                          
                          
                          1,018,405
                          
                          
                          
                          1,075,499Change
      during 2008 -
                          
                          
                          -,-
                          
                          
                          
                          -,-
                          
                          
                          
                          -,-
                          
                          
                          
                          -,-At
      December 31, 2008
                          
                          
                          43,372,819
                          
                          
                          
                          57,094
                          
                          
                          
                          1,018,405
                          
                          
                          
                          1,075,499
  The total
authorized number of ordinary shares as of December 31, 2008 and 2007 is 100
million shares with a par value of NIS 1 per share. All issued shares are fully
paid.
  F-52
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 15 – SHARE CAPITAL AND
PREMIUM (continued):
 
 In July
1996, the Company completed a global offering of 6,900,000 American Depositary
Shares (ADS), each ADS representing one Ordinary share, at a price per share of
$11. In addition, in June 1999, 1,500,000 ADS were issued upon the exercise of
stock options.
 
 The ADS
are traded on the New York Stock Exchange (NYSE). The issued shares represent as
of December 31, 2008 1.3% of the outstanding Ordinary Shares of the Company. As
of December 31, 2008 the shares are quoted at $ 5.85 per ADS share.
 
 Commencing
in November 2000, the Company’s shares have also been listed for trading on the
Tel Aviv Stock Exchange. As of December 31, 2008 the shares are quoted at NIS
21.36 per ordinary share.
 
 During
2007, Company debentures with a par value of approximately NIS 107,636 thousands
were converted into 3,679,836 ordinary shares.
 
 Share
options plan
 
 On
January 21, 2008,  the Company's Board of Directors had resolved to
adopt a share options plan (hereinafter - "the plan") for managers and employees
of the Company. The total number of shares reserved for issuance under the plan
will be 5 million shares, (including options issuable to the Company's newly
appointed President and Chief Executive Officer, Mr. Zeev Vurembrand). All
exercises of options under the plan are to be on a cashless basis. Each option
can be exercised to purchase one ordinary share of NIS 1 par value of the
Company. Immediately upon allotment, the ordinary shares issued upon exercise of
the options will have the same rights as other ordinary shares of the
Company.
 
 Under the
plan, employees and/or managers who will exercise the options would be allotted
only shares that reflect the benefit component embodied in the options, as
computed at date of exercise, i.e., the difference between the exercise price of
each option and the quoted price of a NIS 1 par value share at date of
exercise.
 
 a)
                  In
      March 2008, the Company granted 2,452,500 options to employees and
      2,200,000 options to managers, who will be entitled to exercise the
      options at the end of the following vesting periods: 66.7% at the end of
      two years from the date of grant and the remaining 33.3% at the end of
      three years from the date of grant. The options granted to employees and
      managers can be exercised in the period of 30 days and 6 months from the
      end of the vesting period, respectively. Any options not exercised by this
      date will expire.
 
 The
      exercise price for employees and managers on the day options were granted
      is NIS 36.15 (unlinked) and NIS 39.06 (unlinked) per share,
      respectively. The quoted price of the Company’s ordinary shares,
      immediately before the date of approval of the grant of options by the
      Board of Directors, was NIS 36.15.
 The
      average fair value of the options granted to employees and managers at the
      grant date - computed according to the Black&Scholes option-pricing
      model - is approximately NIS 6.12 and NIS 5.57, respectively. This
      value is based on the following assumptions: expected dividend yield of
      6.4%; expected volatility of approximately 28%; risk-free interest rate of
      approximately 4.5%; and anticipated term until the end of the exercise
      period. Volatility is based on historical volatility of the Company’s
      share price for periods matching the expected term of the option until
      exercise.
  F-53
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 15 – SHARE CAPITAL AND
PREMIUM (continued):
 
 b)
                  In
      May 2008, the Company granted 140,000 options to managers, who will be
      entitled to exercise the options at the end of the following vesting
      periods: 66.7% at the end of two years from the date of grant and the
      remaining 33.3% at the end of three years from the date of grant. The
      options granted to managers can be exercised in the period of 6 months
      from the end of the vesting period. Any options not exercised by this date
      will expire.
 The
exercise price for managers on the day options were granted is NIS 39.06
(unlinked) per share. The quoted price of the Company’s ordinary shares,
immediately before the date of approval of the grant of options by the Board of
Directors, was NIS 46.0.
 The
average fair value of the options granted to managers at the grant date -
computed according to the Black & Scholes option-pricing model - is
approximately NIS 13.2. This value is based on the following assumptions:
expected dividend yield of 6.4%; expected volatility of approximately 29%;
risk-free interest rate of approximately 5.1%; and anticipated term until the
end of the exercise period. Volatility is based on historical volatility of the
Company’s share price for periods matching the expected term of the option until
exercise.
 
 c)
                  In
      August 2008, the Company granted 135,500 options to employees and 100,000
      options to managers, who will be entitled to exercise the options at the
      end of the following vesting periods: 66.7% at the end of two years from
      the date of grant and the remaining 33.3% at the end of three years from
      the date of grant. The options granted to employees and managers can be
      exercised in the period of 30 days and 6 months from the end of the
      vesting period, respectively. Any options not exercised by this date will
      expire.
 
 The
exercise price for employees and managers on the day options were granted is
NIS 36.15 (unlinked) and NIS 39.06 (unlinked) per share, respectively. The
quoted price of the Company’s ordinary shares, immediately before the date of
approval of the grant of options by the Board of Directors, was NIS
36.23.
 The
average fair value of the options granted to employees and managers at the grant
date - computed according to the Black-Scholes option-pricing model - is
approximately NIS 6.7 and NIS 6.1, respectively. This value is based on the
following assumptions: expected dividend yield of 7.5%; expected volatility of
approximately 30%; risk-free interest rate of approximately 5.1%; and
anticipated term until the end of the exercise period. Volatility is based on
historical volatility of the Company’s share price for periods matching the
expected term of the option until exercise.
 
 The plan
is governed by the terms stipulated by Section 102 of the Israeli Income Tax
Ordinance. In accordance with the track chosen by the Company and pursuant to
the terms thereof, the Company is not allowed to claim, as an expense for tax
purposes, the amounts credited to employees as a benefit, including amounts
recorded as salary benefits in the Company’s accounts, in respect of options granted
to employees under the plan - with the exception of the work-income benefit
component, if any, determined on the grant date.
 
 Following
the dividend distribution in October 2008, the option exercise price per share
for employees and mangers was adjusted. The adjusted price for employees is NIS
34.42 and for managers is NIS 37.33.
 
 In
respect of the options plan, the Company recorded in its financial statements in
the year of 2008, a total expense amount to NIS 8 million.
  F-54
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 15 – SHARE CAPITAL AND PREMIUM(continued):
 
 Average
exercise prices are as follows:
 
 Average exercise
                          price per share *
                          (NIS)
                      
                      
                      Number of
                          options
                          (thousands)At January 1, 2008
                      
                      
                      -
                      
                      
                      
                      -Granted
                      
                      
                      35.83
                      
                      
                      
                      5,028Forfeited
                      
                      
                      34.42
                      
                      
                      
                      (159
                      )At
      December 31, 2008
                      
                      
                      35.88
                      
                      
                      
                      4,869Options
      can be exercised at December 31, 2008
                      
                      
                      -
                      
                      
                      
                      -
 
 *
                  After
      adjusting the option exercise price at the rate of 50% of cash dividends
      distributed.
 
 Share
options outstanding at the end of the year have the following expiry date and
exercise prices:
 
 December 31, 2008Number of
                            options
                            (thousands)
                        
                        Range of
                            exercise prices
                            (NIS)
                        
                        
                        Average of
                            expiry date
                            (years)4,869
                        
                        
                        34.42-37.33
                        
                        
                        
                        1.6
 
 Share
options plans in subsidiaries
 
 a.
                    In
      August 2008, BSRE's Board of Directors had resolved to adopt a share
      options plan for managers of BSRE. The total number of shares reserved for
      issuance under the plan will be  250,000 shares. All exercises
      of options under the plan are to be on a cashless basis. Each option can
      be exercised to purchase one ordinary share of NIS 1 par value of BSRE.
      Immediately upon allotment, the ordinary shares issued upon exercise of
      the options will have the same rights as other ordinary shares of BSRE.
      The exercise price of the option will set at date of grand, otherwise
      according to the average quoted price of BSRE's ordinary share during the
      30 trading days before the date of the
grant.
 
 Under the
plan, managers who will exercise the options would be allotted only shares that
reflect the benefit component embodied in the options, as computed at date of
exercise, i.e., the difference between the exercise price of each option and the
quoted price of a NIS 1 par value share at date of exercise.
 
 Under the
plan, the options to managers can be exercised in the period of 6 months from
the end of the vesting  period. Any option not exercised by this date
will expire.
 
 In August
2008, BSRE granted 125,000 options to BSRE's Chief Executive Officer, who will
be entitled to exercise the options at the end of the following vesting periods:
66.7% at the end of two years from the date of grant and the remaining 33.3% at
the end of three years from the date of grant. The options can be exercised in
the period of 6 months from the end of the vesting period.
  F-55
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 15 – SHARE CAPITAL AND PREMIUM(continued):
 
 The
exercise price is NIS 51.76 (unlinked) per share. The quoted price of
BSRE's ordinary share before the date of approval of the grant of options by the
Board of Directors, was NIS 46.91.
 
 Therefore,
the benefit component based on Black & Scholes option pricing model is NIS
7.11 in respect of the first batch and 9.83 in respect of the second batch, so
that the total fair value amounts to NIS 1. million.
 
 The fair
value is based on the following assumptions: expected volatility of
approximately 26%; risk-free interest rate of approximately 5%; and anticipated
term until the end of the exercise period. The exercise price would be adjusted
at the rate of 50% of cash dividends distributed during the term of the
options.
 
 In
respect of the options plan, BSRE recorded in its financial statements in the
year of 2008, a total  expense amount to NIS 0.2 million.
 
 b.
                  In
      August 2005, Na'aman's Board of Directors had resolved to adopt a share
      options plan for employees of Na'aman. The total number of shares reserved
      for issuance under the plan will be  300,000 shares. All
      exercises of options under the plan are to be on a cashless basis. Each
      option can be exercised to purchase one ordinary share of NIS 1 par value
      of Naaman. Immediately upon allotment, the ordinary shares issued upon
      exercise of the options will have the same rights as other ordinary shares
      of Na'aman.
 
 Under the
plan employees who will exercise the options would be allotted only shares that
reflect the benefit component embodied in the options, as computed at date of
exercise, i.e., the difference between the exercise price of each option and the
quoted price of a NIS 1 par value share at date of exercise.
 
 In
November 2005, Na'aman granted 300,000 options to employees, who will be
entitled to exercise the options at the end of the following vesting periods:
33% at the end of November 2006, 33% at the end of November 2007 and the
remaining  34% at the end of November 2008. The options granted to
employees can be exercised by the end of May 2009. Any options not exercised by
this date will expire.
 
 The
exercise price is NIS 5.95 linked to Israeli CPI, subject to adjustments in
the event of distribution of bonus shares and cash dividends. The quoted price
of Na’aman's ordinary share, immediately before the date of approval of the
grant of options by the Board of Directors, was NIS 9.7.
 
 The
average fair value of the options granted to employees at the grant date -
computed according to the quoted price of Na’aman's warrant in November 2005 is
NIS 2.
 
 As of
December 31, 2008 any option did not exercise or expire.
 
 F-56
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
16 – OTHER RESERVES:
  Available-for-sale
                          investmentsNIS in thousandsAt January
      1, 2007
                      
                      
                      -Revaluation
      – gross
                      
                      
                      3,090Revaluation
      – tax
                      
                      
                      (896
                      )Gain
      from sales transfer to finance income/expenses – gross
                      
                      
                      (1,097
                      )Gain
      from sales transfer to finance income/expense – tax
                      
                      
                      318At
      December 31, 2007
                      
                      
                      1,415Revaluation
      – gross
                      
                      
                      (1,105
                      )Revaluation
      – tax
                      
                      
                      342Impairment
      transfer to finance expense- gross
                      
                      
                      2,112Impairment
      transfer to finance expense- tax
                      
                      
                      (559
                      )Gain
      from sales transfer to finance income/expense- gross
                      
                      
                      (3,338
                      )Gain
      from sales transfer to finance income/expense- tax
                      
                      
                      872At
      December 31, 2008
                      
                      
                      (261
                      )
 
 NOTE
17 – ACCUMULATED DEFICIT:
  NIS in thousandsAt January
      1, 2007
                      
                      
                      29,539Profit
      for the year
                      
                      
                      143,628Dividends
      paid
                      
                      
                      (280,000
                      )Actuarial
      loss on post employment benefit obligations, net of tax
                      
                      
                      (429
                      )At
      December 31, 2007
                      
                      
                      (107,262
                      )Profit
      for the year
                      
                      
                      104,586Dividends
      paid
                      
                      
                      (150,000
                      )Share-based
      payment
                      
                      
                      7,969Actuarial
      loss on post employment benefit obligations, net of tax
                      
                      
                      (10,012
                      )At
      December 31, 2008
                      
                      
                      (154,719
                      )
 
 NOTE
18 – OTHER ACCOUNT PAYABLES AND ACCRUED EXPENSES:
 
 December 312007
                      
                      
                      2008NIS in thousandsPayroll
      and related expenses and other employee benefits
                      
                      
                      129,910
                      
                      
                      
                      136,886Government
      authorities
                      
                      
                      22,774
                      
                      
                      
                      6,309Liability
      in respect of gift certificates
                      
                      
                      148,754
                      
                      
                      
                      167,919Derivative
      financial instrument (see note 12)
                      
                      
                      11,593
                      
                      
                      
                      -Accrued
      expenses and other
                      
                      
                      91,898
                      
                      
                      
                      126,696Total
                      
                      
                      404,929
                      
                      
                      
                      437,810
 
 F-57
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
19 - LOANS FROM BANKS, DEBENTURES AND CONVERTIBLE DEBENTURES:
 
 1)
Loans from banks
 
 a.
                  Composition:
 
 December 312007
                      
                      
                      2008NIS in thousandsCurrent
      liabilities:Bank
      overdrafts (note 14)
                      
                      
                      3,381
                      
                      
                      
                      12,187Bank
      loans
                      
                      
                      50,368
                      
                      
                      
                      65,801Current
      maturities
                      
                      
                      117,261
                      
                      
                      
                      132,913171,010
                      
                      
                      
                      210,901Non-current
      liabilities:Bank
      loans
                      
                      
                      248,488
                      
                      
                      
                      341,586419,498
                      
                      
                      
                      552,487
 
 b.
                  Composition
      and details of liabilities based on interest rates and linkage
      terms
 
 December 31Weighted
                          interest rate(a)
                      
                      
                      2007
                      
                      
                      2008%
                      
                      
                      NIS in thousandsNIS
      - Link to the Israeli CPI
                      
                      (b)
                      
                      
                      5.1
                      
                      
                      
                      189,851
                      
                      
                      
                      113,880NIS
      - Unlink and bears a fixed annual interest
                        rate
                      
                      (c)
                      
                      
                      5.5
                      
                      
                      
                      48,750
                      
                      
                      
                      305,456NIS
      - Unlink and bears a variable annual
                        interest
      rate
                      
                      (d)
                      
                      
                      4.6
                      
                      
                      
                      180,897
                      
                      
                      
                      133,151419,498
                      
                      
                      
                      552,487
 (a)
                  Weighted
      average interest rate, as of December
31,2008.
 
 (b)
                  As
      of December 31, 2008 includes approximately NIS 45 million at weighted
      average interest rate of 4.3% and the balance of approximately NIS 69
      million is at weighted average interest rate of
  5.6%.
 
 (c)
                  As
      of December 31, 2008 includes: NIS 215 million at interest rate of 4.8%
      and the balance of approximately NIS 90 million is at weighted average
      interest rate of 7%.
 
 (d)
                  As
      of December 31, 2008 includes: approximately NIS 50 million at weighted
      average interest rate of 4.7% ; approximately NIS 61 million at weighted
      average interest rate of 4.8%. The balance of approximately NIS 22 million
      is at weighted average interest rate of
4%.
   F-58
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 19 - LOANS FROM BANKS,
DEBENTURES AND CONVERTIBLE DEBENTURES(continued):
 
 c.      The
long-term loans are repayable in the years subsequent to the balance sheet date
as follows :
 
 December
      312007
                      
                      
                      2008NIS
      in thousandsSecond
      year
                      
                      
                      86,910
                      
                      
                      
                      97,832Third
      year
                      
                      
                      52,571
                      
                      
                      
                      79,791Fourth
      year
                      
                      
                      36,067
                      
                      
                      
                      61,295Fifth
      year and afterwards
                      
                      
                      72,940
                      
                      
                      
                      102,668248,488
                      
                      
                      
                      341,586
 
 d.      The
carrying amounts and fair value of the non-current loans are as
follows:
 
 December 312007
                      
                      
                      2008
                      
                      
                      2007
                      
                      
                      2008NIS in thousandsCarrying amount
                      
                      
                      Fair valueBank
      loans
                      
                      
                      365,498
                      
                      
                      
                      474,499
                      
                      
                      
                      358,732
                      
                      
                      
                      477,750
 
 The fair
values of long-term loans are based on cash flows discounted using a rate based
on the capitalization rate of 4.7% - 5.7% (linked) to the Israeli CPI and 4% -
7.5% (unlinked).
 
 The
carrying amounts of short-term loans approximate their fair value.
 
 e.     Financial
covenants
 
 Bee Group
and its investee companies have loans in total amount of approximately NIS 146
million, whereby the companies have undertaken to meet certain financial
covenants. As of December 31,2008, Bee Group and its investee companies meet the
above mentioned covenants.
 
 F-59
 
 BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 19 - LOANS FROM BANKS,
DEBENTURES AND CONVERTIBLE DEBENTURES(continued):
 
 2)
Debentures and convertible debentures
 
 a. Composition
  December
      31, 2008
                  
                  
                  TotalIssued
      by
                  
                  
                  December
      31The
      company
                  
                  
                  Subsidiaries
                  
                  
                  2008
                  
                  
                  2007Debentures
                  
                  
                  Convertible
                      debentures
                  
                  
                  Debentures
                  
                  
                  Convertible
                      debentures
                  
                  
                  Debentures
                  
                  
                  Convertible
                      debentures
                  
                  
                  Debentures
                  
                  
                  Convertible
                      debenturesNIS
      in thousandsFace
      value of debentures and conversion component (1)
                  
                  
                  219,266
                  
                  
                  
                  36,622
                  
                  
                  
                  818,280
                  
                  
                  
                  105,696
                  
                  
                  
                  1,037,546
                  
                  
                  
                  142,318
                  
                  
                  
                  866,233
                  
                  
                  
                  141,080Conversion
      component at fair value (2)
                  
                  
                  -
                  
                  
                  
                  7,645
                  
                  
                  
                  -
                  
                  
                  
                  330
                  
                  
                  
                  -
                  
                  
                  
                  7,975
                  
                  
                  
                  -
                  
                  
                  
                  46,140In
      addition of premium (less discount), net of accumulated  amortization
                  
                  
                  (19,681
                  )
                  
                  
                  -
                  
                  
                  
                  (32,021
                  )
                  
                  
                  6,231
                  
                  
                  
                  (51,702
                  )
                  
                  
                  6,231
                  
                  
                  
                  (47,356
                  )
                  
                  
                  6,486199,585
                  
                  
                  
                  44,267
                  
                  
                  
                  786,259
                  
                  
                  
                  112,257
                  
                  
                  
                  985,844
                  
                  
                  
                  156,524
                  
                  
                  
                  818,877
                  
                  
                  
                  193,706Less
      - current maturities of face value of debentures and convertible
      debentures (1)
                  
                  
                  -
                  
                  
                  
                  18,311
                  
                  
                  
                  -
                  
                  
                  
                  43
                  
                  
                  
                  -
                  
                  
                  
                  18,354
                  
                  
                  
                  69,859
                  
                  
                  
                  -Less
      - current maturities of conversion component
                  
                  
                  -
                  
                  
                  
                  7,645
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  7,645
                  
                  
                  
                  -
                  
                  
                  
                  -199,585
                  
                  
                  
                  18,311
                  
                  
                  
                  786,259
                  
                  
                  
                  112,214
                  
                  
                  
                  985,844
                  
                  
                  
                  130,525
                  
                  
                  
                  749,018
                  
                  
                  
                  193,706NIS
      1 par value (in thousands)
                  
                  
                  200,000
                  
                  
                  
                  33,455
                  
                  
                  
                  775,000
                  
                  
                  
                  100,000
                  *
    (1)  See
also b bellow.
 (2)  The
fair value is calculated based on the binominal model, as follows:
 
 December
      31, 2007
                        
                        
                        December
      31, 2008Subsidiaries
                        
                        
                        
                        
                        
                        SubsidiaryThe
      Company
                        
                        
                        BSRE
                        
                        
                        Na’aman
                        
                        
                        The
      Company
                        
                        
                        BSREDiscount
      rate
                        
                        
                        6.13%
                        
                        
                        
                        5.00%
                        
                        
                        
                        2.10%-3.20%
                        
                        
                        
                        5.81%
                        
                        
                        
                        6.75%Share
      price (NIS)
                        
                        
                        51.90
                        
                        
                        
                        54.00
                        
                        
                        
                        10.18
                        
                        
                        
                        21.36
                        
                        
                        
                        49.00Standard
      deviation of  the share price
                        
                        
                        24.58%-27.16%
                        
                        
                        
                        29.54%-31.08%
                        
                        
                        
                        43.4%
                        
                        
                        
                        39.24%-62.57%
                        
                        
                        
                        32.57%-32.97
                        %
 F-60





BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 19 – LOANS FROM BANKS, DEBENTURES AND
CONVERTIBLE DEBENTURES(continued):





b.
            The
      debentures and the convertible debentures (linked to the Israeli CPI)
      are  repayable in the years subsequent to the balance sheet date
      as follows (not including premium or discount)
:





December
      312007
                  
                  
                  2008NIS
      in thousandsFirst
      year - current maturities
                  
                  
                  69,859
                  
                  
                  
                  18,354Second
      year
                  
                  
                  18,506
                  
                  
                  
                  73,117Third
      year
                  
                  
                  47,587
                  
                  
                  
                  18,339Fourth
      year
                  
                  
                  18,506
                  
                  
                  
                  48,754Fifth
      year and afterwards
                  
                  
                  852,855
                  
                  
                  
                  1,021,300Total
                  
                  
                  1,007,313
                  
                  
                  
                  1,179,864





c.
            The
      carrying amounts and fair value of the debentures and the convertible
      debentures are as follows:





December
      312007
                
                
                2008
                
                
                2007
                
                
                2008NIS
      in thousandsCarrying
      amount
                
                
                Fair
      valueDebentures
                
                
                818,877
                
                
                
                985,844
                
                
                
                865,405
                
                
                
                958,993Convertible
      debentures
                
                
                193,706
                
                
                
                156,524
                
                
                
                185,369
                
                
                
                124,587Total
                
                
                1,012,583
                
                
                
                1,142,368
                
                
                
                1,050,774
                
                
                
                1,083,580





The fair
values of debentures and convertible debentures are based on market
quotes.





d.
            Debentures
      and convertible debentures of the
Company





In August
2003, the Company issued NIS 400 million par value debentures to institutional
investors in consideration for their par value as follows:





(1)
              200
      million registered debentures (Series A) of NIS 1 par value
      each.





These
debentures are linked (principal and interest) to the Israeli CPI, but in the
event that the Israeli CPI is lower than the base index (index known at date of
issuance), the amount of the debentures will not be adjusted below the base
index. The principal is repayable in three equal annual installments on August 5
of each of the years 2012 to 2014, and bears interest at the rate of 5.9% per
annum. The interest is payable semi-annually on February 5 and on August
5.





Notwithstanding
the above, on August 5 of each of the years 2006, 2008 and 2010, the holders of
the debentures will be entitled to early redemption of the principal provided
that on each of the said dates the Company does not repay more than one third of
the par value of the debentures outstanding as of that date.




F-61




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 19 – LOANS FROM BANKS, DEBENTURES AND
CONVERTIBLE DEBENTURES(continued):





Accordingly,
one third of the par value of these debentures outstanding as of
December 31, 2007, was classified as current liabilities.





(2)
              200
      million registered convertible debentures (Series B) of NIS 1 par value
      each





These
debentures are linked (principal and interest) to the Israeli CPI, but in the
event that the Israeli CPI is lower than the base index (index known at date of
issuance), the amount of the debentures will not be adjusted below the base
index. The principal is repayable in three equal annual installments on August 5
of each of the years 2007, 2009 and 2011, and bears interest at the rate of 5.9%
per annum. The interest is payable semi-annually on February 5 and on August
5.





The
debentures (Series B) are convertible to ordinary shares of the Company at a
conversion ratio that is subject to adjustments in the event of distribution of
bonus shares and cash dividends and the issuance of rights. As of December 31
2008, the conversion ratio is that each NIS 20.095 par value of debentures are
convertible to one ordinary share of 1 NIS par value. The aforementioned
conversion ratio is after adjustment for cash dividends distributed since the
date of issuance of the debentures (Series B) until balance sheet date (see also
note 30).





The terms
of the debentures provide that the holders of the debentures will not be
entitled to request the Company to register for trading on the New York Stock
Exchange any shares derived from the conversion of the debentures (Series B).
Such shares will be traded only on the Tel Aviv Stock Exchange
(TASE).





On August
5, 2007, one third (16,727,579 NIS 1 par value) of the remaining convertible
debentures (Series B) as of that date was repaid to the holders of the
debentures.


As to the
conversion of debentures into Company shares in the course of 2007, see note
15.





(3)
              Other
      terms:





(1)
              The
      terms of the debentures (Series A and Series B) provide that in the event
      that the shares of the Company are delisted from trading on the TASE,
      and/or in the event that the shares of the Company are no longer held by
      the public and/or in the event that Standard & Poor's Maalot
      ("S&PMaalot") reduces the Company’s rating to BBB or lower, then
      within three months from one of the above mentioned events the Company,
      subject to the then prevailing law, will offer to acquire the debentures
      at a price equivalent to the price of debentures of the same type
      reflecting a return of 2.5% in excess of the return on Government
      debentures with an average life similar to the remaining average life of
      the debentures of that series as of the date of the offer, but in no event
      will the price exceed the carrying value of the debentures of that
      series.




F-62




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 19 – LOANS FROM BANKS, DEBENTURES AND
CONVERTIBLE DEBENTURES(continued):





(2)
              In
      connection with the rating for the said debentures by Maalot, in July 2003
      the Board of Directors of the Company resolved that the Company will not
      distribute dividends in quarters in which the Company does not meet the
      following financial
covenants:


a)
              For
      the period from date of issuance of the debentures until June 30, 2006,
      the ratio between the Company’s monetary liabilities (as defined by
      Maalot) and the cumulative EBITDA in the preceding four quarters was less
      than 3.5, and for the period from the aforementioned date, the ratio is
      less than 3.





b)
              The
      ratio between the carrying amount of property, plant and equipment on
      which a lien is not recorded and the Company’s monetary liabilities (as
      defined by Maalot) will exceed
1.2.





As of
December 31, 2008, the ratio of its financial obligations to EBITDA as of the
end of 2008 was 3.3 (required ratio of less than 3), and the ratio of its
unencumbered fixed assets to the financial obligations was 1.6.





On May
22, 2009, Maalot S&P announced the downgrade of the rating of the debentures
(Series A and B) from ilAA to ilA+ with a stable rating forecast and the removal
of the Company from negative credit watch.





e.
            Debentures
      and convertible debentures of BSRE





(1)
            Pursuant
      to prospectus dated August 16, 2006, BSRE issued NIS 750 million par value
      debentures:





(a)
            100
      million registered convertible debentures (Series A) of NIS 1 par value
      each.





These
debentures are to be redeemed in four equal annual installments on
August 31 of each year in the period from 2013 through 2016. The Series A
debentures are linked (principal and interest) "CPI" and bear interest at an
annual rate of 6.25%, which is payable every six months, on February 28 and
August 31 of each year from 2007 until the final redemption of the
debentures.  The Series A debentures are convertible into registered
BSRE ordinary shares of NIS 1 par value  of any time through
August 16, 2016, except during the periods from August 17 through August 31 in
each of the years between 2013-2015 (inclusive).  Until August 31,
2008, the conversion could have been effected at the rate of NIS 100 par
value of registered Series A debentures (NIS 96.83 par value after an adjustment
on March 25, 2008, due to distribution of cash dividends) for each ordinary
share of NIS 1 par value; after that date and through August 16, 2016, the
conversion rate will be NIS 300 par value of registered Series A debentures
(NIS 281.83 par value, after an adjustment on April 7, 2009, due to distribution
of cash dividends) for each ordinary share of NIS 1 par value. The
conversion rate is subject to adjustments in the event of distribution of cash
dividends.





(b)
            650
      million registered debentures (Series B) of NIS 1 par value
      each.





These
debentures are to be redeemed in four equal annual installments on
August 31 of each year in the period from 2013 through 2016.  The
Series B debentures are linked to the CPI and bear interest at an annual rate of
4.7%, which is payable every six months, on February 28 and August 31 of each
year from 2007 until the final redemption of the debentures.




F-63




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 19 – LOANS FROM BANKS, DEBENTURES AND
CONVERTIBLE DEBENTURES(continued):





(c)
            Expansion
      of Series B





On
September 26, 2008, the BSRE Series B was expanded by way of private allocation
of NIS 125,000 par value of debentures to institutional
investors.  The debentures (Series B) have been allocated in
consideration for 97.5% of their par value – a total of NIS 121,875 – and their
terms are identical to the terms of the Series B debentures as specified in
section b. above.


The
annual effective interest rate on the debentures, taking into account the
issuance expenses as above, is 6.43%.





(2)
            The
      debentures and convertible debentures of BSRE are rated by Maalot S&P
      at ilAA-. In order to maintain the present rating BSRE needs to keep
      certain covenants regarding the ratio of net debt to EBIDA and net debt to
      equity. As of December 31, 2008, BSRE meets the above mentioned
      covenants.





On May
27, 2009, S&P Maalot announced that in connection with the downgrade of the
rating of the Company debentures, they will reassess the present rating of BSRE
debentures.





NOTE
20 – OTHER LIABILITIES:


December
      31,2007
                
                
                2008NIS
      in thousandsLiability
      to Israel Land Admonition
                
                
                5,250
                
                
                
                4,704Long
      term liabilities, net of current portion
                
                
                4,785
                
                
                
                4,076Put
      option granted to a minority interest (see note 5a1)
                
                
                
                
                
                
                21,638Other
                
                
                1,611
                
                
                
                9,50711,646
                
                
                
                39,925





NOTE
21 – DEFERRED INCOME TAX:





a.
            Deferred
      income tax assets and liabilities are offset when there is a legally
      enforceable right to offset current tax assets against current tax
      liabilities and when the deferred income taxes assets and liabilities
      relate to income taxes levied by the same taxation authority on either the
      taxable entity or different taxable entities where there is an intention
      to settle the balances on a net basis. The offset amounts are as
      follows:


December
      312007
                
                
                2008NIS
      in thousandsDeferred
      tax assets:Deferred
      tax asset to be recovered after more than 12 months
                
                
                16,070
                
                
                
                25,225Deferred
      tax asset to be recovered within 12 months
                
                
                17,472
                
                
                
                19,28333,542
                
                
                
                44,508Deferred
      tax liabilities:Deferred
      tax liability to be recovered after more than 12 months
                
                
                (56,822
                )
                
                
                (59,343
                )Deferred
      tax liability to be recovered within 12 months
                
                
                (793
                )
                
                
                (984
                )(57,615
                )
                
                
                (60,327
                )Deferred
      tax liabilities, net
                
                
                (24,073
                )
                
                
                (15,819
                )




F-64




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 21 – DEFERRED INCOME TAX(continued):





The
deferred taxes are computed at the tax rates of 25%-26%.





b.
            The
      gross movement on the deferred income tax account is as
      follows:





2007
                
                
                2008NIS
      in thousandsBalance
      at January 1
                
                
                (9,685
                )
                
                
                (24,073
                )Additions
      in respect of companies consolidated for the first time
                
                
                (14,703
                )
                
                
                -Income
      statement charge
                
                
                1,222
                
                
                
                4,000Tax
      charged directly to equity
                
                
                (907
                )
                
                
                4,254Balance
      at December 31
                
                
                (24,073
                )
                
                
                (15,819
                )





c.
            The
      movement in deferred income tax assets and liabilities during the year,
      without taking into consideration the offsetting of balances within the
      same tax jurisdiction, is as
follows:





Deferred
      tax liabilities
                  
                  Depreciable
                      property,
      plant
                      and
      equipment
                      and
      investment
                      property
                  
                  
                  Intangible
                      assets
      and
                      other
                  
                  
                  TotalNIS
      in thousandsBalance
      at January 1, 2007
                  
                  
                  (49,597
                  )
                  
                  
                  666
                  
                  
                  
                  (48,931
                  )Charged/(credited)
      to the income statement
                  
                  
                  4,502
                  
                  
                  
                  1,221
                  
                  
                  
                  5,723Additions
      in respect of companies consolidated for the first time
                  
                  
                  148
                  
                  
                  
                  (16,225
                  )
                  
                  
                  (16,077
                  )Charged
      directly to equity (see note 28)
                  
                  
                  -
                  
                  
                  
                  (1,006
                  )
                  
                  
                  (1,006
                  )Balance
      at December 31, 2007
                  
                  
                  (44,947
                  )
                  
                  
                  (15,344
                  )
                  
                  
                  (60,291
                  )Charged
      to the income statement
                  
                  
                  (9,486
                  )
                  
                  
                  3,267
                  
                  
                  
                  (6,219
                  )Charged
      directly to equity (see note 28)
                  
                  
                  -
                  
                  
                  
                  873
                  
                  
                  
                  873Balance
      at December 31, 2008
                  
                  
                  (54,433
                  )
                  
                  
                  (11,204
                  )
                  
                  
                  (65,637
                  )




F-65




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 21 – DEFERRED INCOME TAX(continued):





Deferred
      tax assets
                
                Provisions
                    for
                    employee
                    rights
                
                
                Carryforwards
                    tax
      losses
                
                
                Derivative
                    instruments
                
                
                Leasehold
                    rights
                
                
                TotalNIS
      in thousandsBalance
      at January 1, 2007
                
                
                23,760
                
                
                
                4,329
                
                
                
                4,778
                
                
                
                6,379
                
                
                
                39,246Charged/(credited)
      to the income  statement
                
                
                (764
                )
                
                
                54
                
                
                
                (5,289
                )
                
                
                1,498
                
                
                
                (4,501
                )Charged
      directly to equity (see note 28)
                
                
                99
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                99Additions
      in respect of companies consolidated for the first time
                
                
                1,374
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,374Balance
      at December 31, 2007
                
                
                24,469
                
                
                
                4,383
                
                
                
                (511
                )
                
                
                7,877
                
                
                
                36,218Charged
      to the income statement
                
                
                3,009
                
                
                
                2,442
                
                
                
                4,150
                
                
                
                618
                
                
                
                10,219Charged
      directly to equity (see note 28)
                
                
                3,381
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,381Balance
      at December 31, 2008
                
                
                30,859
                
                
                
                6,825
                
                
                
                3,639
                
                
                
                8,495
                
                
                
                49,818





d.
            Losses
      for tax purposes, carried forward to future
  years





As of
December 31, 2008 and 2007 the subsidiaries have operating tax loss
carryforwards of approximately NIS 56.5 and NIS 16.4 million, respectively. The
balance of carryforward losses, in respect of which deferred tax assets were not
included, amount to NIS 35.6 million and NIS 6 million as of December 31,
2008 and 2007, respectively. In addition, the Company and its subsidiaries have
capital loss tax carryforwards of approximately NIS 28.1 million and NIS 19.4
million as of December 31, 2008 and 2007, respectively. The tax benefit in
respect of capital tax loss carryforwards amounting to NIS 21.8 million has
not been recorded due to uncertainty of their realization.





Under the
inflationary adjustments law, carryforward losses were linked to the CPI. In
February 2008, the Knesset (the Israeli parliament) passed a law according to
which the provisions of Inflationary adjustments law will no longer apply to the
Company in 2008 and thereinafter. The repeal of the Inflationary Adjustments Law
had no material effect on the balance of deferred taxes at December 31,
2008.





NOTE
22 – RETIREMENT BENEFIT OBLIGATIONS:





a.
            Composition:


December
      312007
                    
                    
                    2008NIS
      in thousandsBalance
      sheet obligations for:Present
      value of funded obligation
                    
                    
                    285,114
                    
                    
                    
                    297,525Provision
      in respect of unutilized sick leave
                    
                    
                    23,380
                    
                    
                    
                    29,229308,494
                    
                    
                    
                    326,754Fair
      value of the plan assets
                    
                    
                    272,508
                    
                    
                    
                    276,843Total
      present value of the obligation, net
                    
                    
                    35,986
                    
                    
                    
                    49,911




F-66




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 22 – RETIREMENT BENEFIT
OBLIGATIONS (continued):





b.
            Changes
      in the liability for defined benefit
plans:





2007
                        
                        
                        2008NIS
      in thousandsLiability
      in respect of defined benefit plans at January 1
                        
                        
                        271,757
                        
                        
                        
                        308,494Benefits
      paid
                        
                        
                        (15,484
                        )
                        
                        
                        (21,512
                        )Current
      service costs
                        
                        
                        28,693
                        
                        
                        
                        32,410Actuarial
      losses (gains)
                        
                        
                        2,761
                        
                        
                        
                        (9,953
                        )Interest
      costs
                        
                        
                        14,537
                        
                        
                        
                        17,315Liabilities
      in respect of acquisitions of subsidiaries consolidated for the first
      time
                        
                        
                        6,230
                        
                        
                        
                        -Liability
      in respect of defined benefit plans at December 31
                        
                        
                        308,494
                        
                        
                        
                        326,754





c.
            Changes
      in plans assets:





2007
                      
                      
                      2008NIS
      in thousandsFair
      value of plan assets at January 1
                      
                      
                      240,745
                      
                      
                      
                      272,508Employer
      contributions paid indo the plan
                      
                      
                      25,459
                      
                      
                      
                      29,090Actuarial
      gains (losses)
                      
                      
                      1,900
                      
                      
                      
                      (23,748
                      )Benefits
      paid
                      
                      
                      (13,460
                      )
                      
                      
                      (18,532
                      )Expected
      return on plan assets
                      
                      
                      13,919
                      
                      
                      
                      17,638Other
      adjustments
                      
                      
                      (306
                      )
                      
                      
                      (113
                      )Assets
      in respect of acquisitions of subsidiaries consolidated for the first
      time
                      
                      
                      4,251
                      
                      
                      
                      -Fair
      value of plan assets at December 31
                      
                      
                      272,508
                      
                      
                      
                      276,843





The
actual return (loss) on plan assets was NIS (6,110) (2007 – NIS 15,819) in
thousands.


Expected
contributions to post-employment benefit plans for the year ending 31 December
2009 are NIS 33,000 thousands.





d.
            Expense
      recognized in the income statement in respect of defined benefit
      plans:





For
      the year ended December 312007
                  
                  
                  2008NIS
      in thousandsCurrent
      services costs
                  
                  
                  28,693
                  
                  
                  
                  32,410Interest
      cost
                  
                  
                  14,537
                  
                  
                  
                  17,315Expected
      return on plan assets
                  
                  
                  (13,919
                  )
                  
                  
                  (17,638
                  )Other
      adjustments
                  
                  
                  306
                  
                  
                  
                  11329,617
                  
                  
                  
                  32,200




F-67




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE 22 – RETIREMENT BENEFIT
OBLIGATIONS (continued):





e.
            The
      expenses were included in the following statement of income
      items:





Year
      ended December 312007
                      
                      
                      2008NIS
      in thousandsGeneral
      and administrative expenses
                      
                      
                      28,999
                      
                      
                      
                      32,523Financial
      (income) expenses
                      
                      
                      618
                      
                      
                      
                      (323
                      )29,617
                      
                      
                      
                      32,200





The
principal actuarial assumptions used were as follows:




December
      312007
                  
                  2008Discount
      rate
                  
                  6%-6.35%
                  
                  5.1%-5.4%Inflation
      rate
                  
                  2.6%
                  
                  1.7%Expected
      return on plan assets
                  
                  4.6%-6.35%
                  
                  5.3%-6.15%Future
      salary increases
                  
                  4.3%-8%
                  
                  3.4%-6%Rates
      of employee turnover
                  
                  4%-55%
                  
                  4%-55%





Assumptions
regarding future mortality rates are based on actuarial advice in accordance
with published statistics and past experience in Israel. Mortality rates are
based on the pension circular 2007-3-6 of the Ministry of Finance.





NOTE
23 – PROVISION FOR OTHER LIABILITIES AND CHARGES:





Termination
                    benefits
                
                
                Legal
                  claims
                
                
                TotalNIS
      in thousandsAt
      January 1, 2008
                
                
                -
                
                
                
                35,073
                
                
                
                35,073Charged/(credited)
      to the income statement:
                
                
                -Provisions
      made during the period
                
                
                6,000
                
                
                
                6,072
                
                
                
                12,072Provisions
      reversed during the period
                
                
                -
                
                
                
                (1,304
                )
                
                
                (1,304
                )Provisions
      used during the period
                
                
                -
                
                
                
                (2,444
                )
                
                
                (2,444
                )At
      December 31, 2008
                
                
                6,000
                
                
                
                37,397
                
                
                
                43,397





a.
            Termination
      benefits





The
Company approved a redundancy plan regarding the reduction of headcount in the
Company's headquarters. An agreement was reached with the union representatives
before the financial year-end. The estimated costs to be incurred are NIS 6,000
at December 31, 2008 (see note 26). These costs were fully provided for in 2008.
The provision of NIS 6,000 at December 31, 2008, is expected to be fully
utilized during the first half of 2009.





b.
            Legal
      claims





The
amounts represent a provision for certain legal claims brought against the
Company by customers of the wholesale segment. The provision charge is
recognized in profit or loss within administrative expenses. In the directors’
opinion, after taking appropriate legal advice, the outcome of these legal
claims will not give rise to any significant loss beyond the amounts provided at
December 31, 2008. For more details see note 31.




F-68




BLUE
SQUARE – ISRAEL LTD.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





NOTE
24 – OTHER GAIN (LOSSES):





Year
      ended December 312007
                
                
                2008NIS
      in thousandsOther
      gain:Capital
      gain on decrease on the rate holdings in subsidiary as a result of
      reorganization (see note 5b)
                
                
                -
                
                
                
                12,001Gain
      from sale of property, plant and equipment and reversal of impairment
      provision
                
                
                15,835
                
                
                
                -Other
                
                
                -
                
                
                
                23215,835
                
                
                
                12,233Other
      losses:Capital
      loss on decrease in the rate of holdings in subsidiary
                
                
                1,520
                
                
                
                2,220Termination
      benefits
                
                
                -
                
                
                
                6,000Loss
      from sale and impairment provisions of property, plant and
      equipment
                
                
                10,908
                
                
                
                5,989Other
                
                
                327
                
                
                
                50712,755
                
                
                
                14,716Other
      gain (losses), net
                
                
                3,080
                
                
                
                (2,483
                )





NOTE  25
– EXPENSES BY NATURE:





Year
      ended December 312007
                
                
                2008NIS
      in thousandsChange
      in inventories
                
                
                (20,438
                )
                
                
                (43,136
                )Net
      purchases
                
                
                5,019,277
                
                
                
                5,273,649Wages
      salaries and related expenses
                
                
                675,922
                
                
                
                752,542Depreciation,
      amortization and impairment charges
                
                
                141,100
                
                
                
                153,935Transportation
      and storage expenses
                
                
                122,728
                
                
                
                125,372Advertising
      costs
                
                
                75,811
                
                
                
                87,191Rent
      and maintenance expenses
                
                
                154,238
                
                
                
                183,313Other
      expenses
                
                
                524,148
                
                
                
                631,003Total
      cost of sales, selling general and administrative expenses
                
                
                6,692,786
                
                
                
                7,163,869





NOTE  26
– EMPLOYEE BENEFIT EXPENSES:





Year
      ended December 31,2007
                
                
                2008NIS
      in thousandsWages
      and salaries, including social security costs
                
                
                647,229
                
                
                
                711,957Termination
      benefits
                
                
                -
                
                
                
                6,000Share
      options granted to managers and employees
                
                
                -
                
                
                
                8,175Post-employment
      benefits
                
                
                28,693
                
                
                
                32,410675,922
                
                
                
                758,542Number
      of employees
                
                
                7,421
                
                
                
                7,475


F-69
  BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE
27 – FINANCE INCOME AND EXPENSES:





Year
      ended December 31,2007
                  
                  
                  2008NIS
      in thousandsIncome:Interests:Interest
      income on short-term bank deposits
                  
                  
                  27,896
                  
                  
                  
                  10,668Interest
      income from bank and others
                  
                  
                  8,921
                  
                  
                  
                  8,208Net
      gain from marketable securities
                  
                  
                  4,399
                  
                  
                  
                  7,923Changes
      in fair value of derivatives:Conversion
      component
                  
                  
                  9,262
                  
                  
                  
                  32,744Embedded
      derivatives
                  
                  
                  10,500
                  
                  
                  
                  1,15760,978
                  
                  
                  
                  60,700Expenses:Interest
      and differences from linkage to the Israel the CPI:Bank
      borrowings
                  
                  
                  24,910
                  
                  
                  
                  36,197Debenturesand
      convertible debentures
                  
                  
                  69,910
                  
                  
                  
                  102,670Bank
      commissions and others
                  
                  
                  4,674
                  
                  
                  
                  7,307Changes
      in fair value of derivatives:Conversion
      component
                  
                  
                  18,496
                  
                  
                  
                  1,199Embedded
      derivatives
                  
                  
                  307
                  
                  
                  
                  18,922118,297
                  
                  
                  
                  166,295Net
      finance cost
                  
                  
                  57,319
                  
                  
                  
                  105,595





NOTE
28 – INCOME TAX EXPENSES:





a.
            Corporate
      taxation in Israel





1.
              Measurement
      of results for tax purposes under the Income Tax (Inflationary
      Adjustments) Law, 1985 (hereinafter - “the inflationary adjustments
      law”)





Under the
inflationary adjustments law, results for tax purposes are measured in real
terms, having regard to the changes in the CPI.  The Company and its
subsidiaries are taxed under this law.





In
February 2008, the Knesset (the Israeli parliament) passed a law according to
which the provisions of Inflationary adjustments law will no longer apply to the
Company in 2008 and thereafter.





2.
              Tax
      rates





The
income of the Company and its subsidiaries is taxed at the regular rate. Through
December 31, 2003, the corporate tax was 36%. In July 2004, Amendment No. 140 to
the Income Tax Ordinance was enacted. One of the provisions of this amendment is
that the corporate tax rate is to be gradually reduced from 36% to 30%. In
August 2005, a further amendment (No. 147) was published, which makes a further
revision to the corporate tax rates prescribed by Amendment No. 140. As a result
of the aforementioned amendments, the corporate tax rates for 2005 and
thereafter are as follows: 2005 - 34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009
- 26% and for 2010 and thereafter - 25%.




F-70




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE 28 – INCOME TAX EXPENSES(continued):





Capital
gains that are taxed at a reduced rate of 25% on the capital gains derived after
January 1, 2003 (and as to marketable securities – that were acquired after
January 1, 2006), and at the regular corporate tax rates on income derived
through the aforementioned date.





b.
            Tax
      assessments





1.
              The
      Company has received final tax assessments, or assessments deemed to be
      final, for tax years through 1998 and for 2003.  Regarding tax
      assessments for the years 1999-2001, see also note
  31(f).


Some of
the principal subsidiaries have received final assessments for tax years through
2003. For some of the subsidiaries, no final tax assessments have been received
since their inception.





2.
              As
      to deduction assessment for the years 2001-2004, see note
      31(g),(h).





c.
            Taxes
      on income included in the income
statements:





Year
      ended December 312007
                  
                  
                  2008NIS
      in thousandsCurrent
      tax:Current
      tax on profits for the year
                  
                  
                  76,505
                  
                  
                  
                  47,676Adjustments
      in respect of prior years
                  
                  
                  (5,504
                  )
                  
                  
                  130Total
      current tax
                  
                  
                  71,001
                  
                  
                  
                  47,806Deferred
      tax (note 21)
                  
                  
                  (1,222
                  )
                  
                  
                  (4,000
                  )Income
      tax expense
                  
                  
                  69,779
                  
                  
                  
                  43,806





d.
            The
      income tax charged/(credited) to equity during the year is as
      follows:





Year
      ended December 312007
                  
                  
                  2008NIS
      in thousandsDeferred
      tax:Tax
      on actuarial loss on retirement benefits scheme
                  
                  
                  99
                  
                  
                  
                  3,381Fair
      value charged to equity -available-for-sale financial
      assets and other
                  
                  
                  (1,006
                  )
                  
                  
                  873(907
                  )
                  
                  
                  4,254




F-71




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE 28 – INCOME TAX EXPENSES(continued):





e.
            The
      tax on the Company's profit before tax differs from the theoretical amount
      that would arise using the weighted average tax rate applicable to profits
      of the consolidated entities as
follows:





Year
      ended December 312007
                  
                  
                  2008NIS
      in thousandsProfit
      before tax
                  
                  
                  245,601
                  
                  
                  
                  176,208Theoretical
      tax expenses (27%)
                  
                  
                  71,224
                  
                  
                  
                  47,576Tax
      effects of:Difference
      between the measurement basis of income for tax purposes and the
      measurement basis of income for book purposes, net
                  
                  
                  (2,460
                  )
                  
                  
                  (6,115
                  )Expenses
      not deductible for tax purposes, net
                  
                  
                  3,287
                  
                  
                  
                  9,241Utilization
      of previously unrecognized tax losses
                  
                  
                  -
                  
                  
                  
                  (1,420
                  )Tax
      losses for which no deferred income tax asset was
    recognized
                  
                  
                  -
                  
                  
                  
                  8,031Tax
      benefit recorded for the first time on carry forward capital
      losses
                  
                  
                  337
                  
                  
                  
                  -Decrease
      in taxes resulting from computation of deferred taxes at a rate which is
      different from the theoretical rate
                  
                  
                  (1,205
                  )
                  
                  
                  (2,083
                  )Non-taxable
      financial (income) expenses*
                  
                  
                  4,100
                  
                  
                  
                  (8,746
                  )Capital
      gains for which no deferred tax was recognized
                  
                  
                  -
                  
                  
                  
                  (2,808
                  )Adjustment
      in respect of prior years
                  
                  
                  (5,504
                  )
                  
                  
                  130Tax
      charge
                  
                  
                  69,779
                  
                  
                  
                  43,806





* mainly
resulting from changes in value of conversion component in convertible
debentures.





f.
              The
      effect of adopting IFRS on tax
liability





As
discussed in note 2(a), the company prepares its financial statements under IFRS
commencing on January 1, 2008.





As was
also discussed in the said note, IFRS differs from Israeli GAAP and,
accordingly, financial statements drawn up under IFRS might present financial
positions, operating results and cash flows that are significantly different
from those presented in these financial statements.





On June
17, 2008 a bill for the amendment of the Income Tax Ordinance (No. 166)
(Non-application of the provisions of IFRS – Temporary Order for tax years 2007
and 2008) was suggested to the effect that taxable income for the said tax years
would not be determined based on IFRS; this, in order to enable the Tax
Authorities to consider the application of the principles regarding the taxable
income of companies that are subject to IFRS.  A joint forum was
established for this purpose by the Tax Authorities together with the
professional organizations; the objective of this forum would be discussing
various elucidations of various accounting standard issues which would arise as
part of the application of IFRS in tax returns issued in Israel.  As
of the date of these financial statements, the bill was not passed in the
Kneset.  Also, the said forum has not yet published its
recommendations.





Although
the said bill has not yet been passed, company's management resolved to act
according to the spirit of the bill and computed its taxable income based on
Israeli accounting standards existing prior to adoption of the IFRS, subject to
certain adjustments.




F-72




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE
29 – EARNING PER SHARE:





a.
              Basic





Basic
earnings per share is calculated by dividing the profit attributable to equity
holders of the Company by the weighted average number of ordinary shares in
issue during the year, (see note 15).





2007
                    
                    
                    2008NIS
      in thousandsProfit
      attributable to equity holders of the Company
                    
                    
                    143,628
                    
                    
                    
                    104,586Weighted
      average number of ordinary shares in issue
                    
                    
                    42,355,339
                    
                    
                    
                    43,372,819





b.
            Diluted





Diluted
earnings per share are calculated by adjusting the weighted average number of
ordinary shares outstanding to assume conversion of all dilutive potential
ordinary shares. The Company has two categoriesof dilutive potential ordinary
shares: convertible debt and share options. The convertible debt is assumed
tohave been converted into ordinary shares, and the net profit is adjusted to
eliminate the interest expense less the tax effect.  For the share
options, a calculation is made to determine the number of shares that could
havebeen acquired at fair value (determined as the average annual market share
price of the Company’s shares) based on the monetary value of the subscription
rights attached to outstanding share options. The number of shares calculated as
above is compared with the number of shares that would have been issued assuming
theexercise of the share options.





2007
                  
                  
                  2008NIS
      in thousandsProfit
      attributable to equity holders of the Company
                  
                  
                  143,628
                  
                  
                  
                  104,586Gain
      from conversion feature and Interest expense on convertible debt (net of
      tax)
                  
                  
                  -,-
                  
                  
                  
                  (31,527
                  )Profit
      used to determine diluted earnings per share
                  
                  
                  143,628
                  
                  
                  
                  73,059Weighted
      average number of ordinary shares in issue adjustments
for:
                  
                  
                  42,355,339
                  
                  
                  
                  43,372,819Assumed
      conversion of convertible debt
                  
                  
                  -,-
                  
                  
                  
                  1,664,873Weighted
      average number of ordinary shares for diluted earnings per
      share
                  
                  
                  42,355,339
                  
                  
                  
                  44,987,692





NOTE
30 – DIVIDENDS PER SHARE:





On August
20, 2008 the Board of Directors declared a dividend  in the amount of
NIS 150.0 million (NIS 3.46 per share). The dividend was paid on October 7,
2008.





In April
2007, the Company distributed dividend in the amount of approximately NIS 60
million (NIS 1.45 per share). In October 2007, the Company distributed dividend
in the amount of approximately NIS 220 million (NIS 5.07 per
share).





As to the
Board of Directors decision regarding dividend distribution due to financial
covenants, see note 19.




F-73




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE
31 – CONTINGENCIES:





a.
            From
      April 2000 to May 2003, the Israeli Antitrust Authority conducted an
      investigation into alleged restrictive trade arrangements between major
      supermarkets chains in Israel and large suppliers. During the
      investigation, an inquiry was conducted in the Company's offices and a
      former CEO and other senior officers were
  questioned.





On
      January 5, 2005, the Commissioner of the Israeli Antitrust Authority
      issued his position regarding “commercial restrictive practices between
      the dominant food suppliers and the major supermarket retail chains”.
      According to the Commissioner’s position, some of these practices were
      found to be restrictive trade agreements under the antitrust laws. The
      Commissioner prohibited these practices unless approved by the Restrictive
      Trade Practices Court or exempted by the Commissioner
    himself.


Among
      the practices that were found to be restrictive according to the
      Commissioner were the following: arrangements with suppliers that
      determine the suppliers of the retail chains, their identity and their
      number; arrangements for the management of product categories in
      conjunction with suppliers; arrangements regarding the retail selling
      price; arrangements for determining market share of a particular
      supplier’s products and arrangements for determining prices made by
      suppliers to competing chains; arrangements with regard of the use of
      suppliers’ manpower to stock merchandise on the shelves of the chain
      stores. Limits were imposed on financial benefits to the chains with
      regard to display areas and on special offers to chains for meeting
      certain sale targets. After the publication of the position paper, the
      Commissioner stated his position that these directives constitute a
      position paper, which is “intended to provide the guidance concerning the
      normative status of various practices in the food retail industry as
      perceived by the Antitrust Authority”. The Commissioner indicated that
      this document does not have normative
status.


The
      Company has been applying most of these directives among others, by
      adopting an internal compliance
program.





Presently
      the Company has no knowledge of how, if at all, its business would be
      affected should the Commissioner take any action against it, with respect
      to those issues under dispute, which to the Company's opinion are legal
      based on consultations with its legal
counsel.





In
      August 2006, the Restrictive Trade Practices Court approved a consent
      decree reached between the Commissioner and certain food
      suppliers.  The consent decree is directed at the food suppliers
      listed therein and stipulates various prohibitions, conditions and
      restrictions that apply to these suppliers with regard to certain
      practices. The consent decree addresses the following arrangements:
      Reduction in the number of suppliers, acquisition of shelf and off-shelf
      display space, category management, discounts and rebates in exchange for
      meeting sales targets, setting market share, exclusivity in sales, price
      dictation by supplier, and shelve
arrangements.





As
      to shelve arrangements: whereas in his position document, the Commissioner
      determined that the use of suppliers’ representatives to physically
      arrange the shelves in the chains’ stores constitutes a restrictive
      arrangement, the suppliers disagree with this position, and the
      Commissioner agreed not to take enforcement measures with regard to such
      arrangements for 30 months, so long as such arrangements satisfy certain
      conditions. In February 2009, the above period was extended by 36 months,
      until February 2012.





The
      consent decree clarifies that nothing in the provisions contained therein
      prevents the chain stores from allocating shelf space at its own
      independent discretion, even if such allocation exceeds half the available
      shelf space, so long as there is no involvement or interference from the
      supplier and so long as there is no prior coordination or understanding
      with said supplier.




F-74




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE 31 – CONTINGENCIES(continued):





The
      Company is not a party to the consent decree; however, it could
      nevertheless have an effect on the practices of the Company’s suppliers
      and indirectly on the Company. At this stage, the Company cannot estimate
      the effect of the Commissioner's position and the consent decree on its
      financial results.





b.
              In
      2002, the Commissioner of the Antitrust Authority announced that the
      arrangements relating to the gift certificates issued by the Company and
      other supermarket chains apparently constitute a restrictive arrangement
      pursuant to the Israeli antitrust law.  At this stage, the
      Company cannot assess the impact of the aforementioned announcement on its
      business.  Following the announcement, the Company decided to
      cease issuing the gift certificates jointly with other supermarket chains
      and are presently issuing its own gift
  certificates.





c.
              The
      operation of the Company’s supermarkets in Israel requires permits from
      municipal authorities, which are conditioned on the prior approval of
      various agencies, including the Health and Environment ministries and the
      Police and Fire Departments. Some of these permits are currently in the
      name of the Co-Op Blue Square Services Society, or the Co-Op, our former
      controlling shareholder, and entities other than the Company, and have not
      yet been transferred or re-issued to the Company. Furthermore, as a result
      of the hostilities between Israel and the Palestinians, the relevant
      authorities, including the police, have required the Company to adopt
      various security measures. These safety requirements prescribe extensive
      investment in safety equipment, the retaining of security personnel and
      may lengthen the time dedicated for obtaining permits from the municipal
      authorities. In the event that the Company is unable to obtain or maintain
      the required permits, it may be required to close the affected stores or
      take other action. However, the Company does not anticipate that not
      obtaining the necessary permits will have a material adverse effect on its
      business.





d.
              In
      February 2008, a claim was filed against the Company and other defendants,
      including companies involved in the marketing of eggs and other food
      marketing chains. The plaintiffs have requested to certify the claim as a
      class action.  The claim alleged that the defendants market
      and/or display for purchase eggs that are classified as "Super
      Fresh Eggs" which are not subject to Israeli regulatory price
      controls, and are thus minimizing the shelf space and/or display
      of eggs that are subject to regulatory price controls.  In
      August 2008, at the recommendation of the court, the plaintiff has applied
      to the court to dismiss his claim, and the court then dismissed the claim.
      Furthermore, the court determined that should the plaintiff refile the
      claim, he would bear the expenses of each defendant in the refiled claim,
      in the sum of NIS 15,000 plus VAT, interest, and
  linkage.





e.
              In
      June 2008, a claim was filed against a subsidiary, Blue Square Chain
      (Hyper Hyper) Ltd. (hereinafter - Hyper Hyper)  and other
      defendants, in connection with the marketing of ink cartridges. The
      plaintiffs have requested to certify the claim as a class
      action.  The claim alleges that the defendants coordinated the
      prices of certain Hewlett-Packard ("HP") ink cartridges sold by them in a
      manner that allegedly constitutes an agreement in restraint of trade.
      According to the claim, the defendants allegedly sell HP ink cartridges
      for a higher price than the price charged for such ink cartridges by
      smaller retailers.  The plaintiff's personal claim is estimated
      at NIS 496, and if the claim is certified as a class action, the
      approximate claim against all the defendants is estimated by the plaintiff
      at NIS 81 million. The claim requests a declaratory relief of an agreement
      in restraint of trade, monetary compensation and an injunction to stop the
      alleged price coordination.




F-75




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE 31 – CONTINGENCIES
(continued):





At this
preliminary stage of the proceedings, the Company is unable to evaluate its
likelihood of success in the proceedings, including the likelihood that the
claim will be certified as a class action.





f.
            In
      2005, the Income Tax Authority issued to the Company tax assessment orders
      for the years 1999-2001 alleging that certain finance expenses in the
      amount of approximately NIS 17 million are not to be recognized for tax
      purposes on the basis that such expenses were associated with loans
      incurred for the purpose of distributing a dividend. In 2005, the Company
      filed an appeal with the District Court contesting these assessments. In
      January 2009 the appeal was accepted, in common consent by the
      parties.





g.
              In
      July 2005, the Income Tax Authority issued to the Company a notice of a
      deduction assessment for the years 2001- 2004. The amount claimed under
      these assessments totaled NIS 34 million, and primarily relates to
      certain benefits granted to employees in the Company’s branches. In
      November 2005, several senior employees were questioned under warning,
      with respect to these benefits. Following these assessments and after the
      rejection of the Company's position on the matter, Income Tax Authority
      issued to the Company deduction assessment orders for the years 2001- 2004
      in the amount of approximately NIS 44 million. The Company filed appeals
      with the District Court contesting these assessment orders which as of the
      filing of this Annual Report are still pending.  In the opinion
      of the Company and its advisors, the provisions included in the Company
      financial statements are sufficient to cover the potential
      liabilities.





h.
              In
      July 2007, the Israeli Tax Authority issued to the Company Value Added Tax
      assessment for the years 2001- 2006 in the amounts of approximately NIS 22
      million in connection with the foregoing deduction assessments as
      specified in clause g. The Israeli Tax Authority did not accept most of
      the Company's assertions, although it agreed to deduct the total amount to
      NIS 16.3 million. The Company filed an appeal with the District Court on
      February 2009, which as of the filing of this Annual Report is still
      pending. In the opinion of the Company and its advisors, the provisions
      included in the Company financial statements are sufficient to cover the
      potential liabilities.





i.
              In
      January 2009, the Company was served with a claim and a request for
      approval as a class action, in which it is being sued regarding the
      return of a credit note instead of cash, in accordance with the Deposit on
      Drink Containers Law 1999. The Claim alleges that Blue Square has to
      return cash returns to customers returning empty reusable bottles
      according to the law, while in fact instead of returning cash returns, it
      gives the customers  a credit note. The plaintiff's personal
      claim is estimated at NIS 51.75 and if the claim is approved as a class
      action, the approximate claim is estimated by the plaintiff at NIS 5.8
      million. The Company denies all allegations, however, at this preliminary
      stage of the proceedings, it is unable to evaluate the likelihood of
      success in the proceedings, including the likelihood that the Claim will
      be certified as a class
action.





j.
              The
      Company is involved in various other legal or other proceedings incidental
      to the ordinary course of its business.   Management of the
      Company believes, based upon the opinions of the legal advisers handling
      the claims, that the amounts provided in the financial statements are
      sufficient under the circumstances, and that none of these proceedings,
      individually or in the aggregate, will have a material adverse effect on
      its business, financial position or operating
  results.
  F-76
  BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE
32 – COMMITMENTS:





a.
              On
      December 26, 2006, all conditions precedent for the completion of the
      agreement between the Company and Dor Alon Energy (1988) Ltd., a related
      party, (hereinafter - Dor Alon), the first party, and Cal - Israel Credit
      Cards Ltd. (hereinafter - CAL) and Diners Club Israel Ltd (hereinafter -
      Diners Israel), a subsidiary of CAL, the second party, were
      satisfied.


According
      to the said agreement, the Company and Dor Alon jointly purchased from CAL
      49% of the issued share capital of Diners in consideration for a total
      amount of approximately NIS 21.3 million (hereinafter - the
      Consideration). The holdings of the Company and Dor Alon in the issued
      share capital of Diners are as follows: The Company - 36.75% and Dor Alon
      - 12.25%. The consideration was financed through a non recourse loan
      provided by CAL to the Company and Dor Alon. The loan is for a period of 8
      years, and it is linked to the CPI and bears interest in an annual rate of
      6%. The loan will be repaid in a single payment at the end of the period.
      The loan and interest are secured only by the shares of Diners. Both
      parties can cancel the agreement if, at the end of a period of 4 years
      and/or 6 years, the number of credit cards will not exceed a pre-agreed
      quantity, as set in the agreement, or if the loyalty plan ceases to
      function or the customer club agreement (referred to in a below) is
      terminated.





Furthermore,
      the Company and Dor Alon are entitled to receive income arising from the
      activity of the loyalty program, in proportion to their holdings in the
      shares of Diners.  The entitlement of the Company and Dor Alon
      to participate in the income from that activity of Diners, which is not
      part of the loyalty program’s activity, is contingent upon meeting some
      milestones in defined periods of times as specified in the
      agreement.  As of the date of this report, the entitlement has
      not yet been established as aforementioned, and hence, the Company has not
      presented its share in the investment in Diners, and in conjunction, no
      liability was recorded in respect of its share in the said loan. The
      Company and Dor Alon will be entitled, under certain conditions and during
      a pre-defined period, to purchase the right to participate in the income
      of Diners, against a one-time
payment.




b.
              In
      addition, the Company entered two additional
  agreements:





1.
              An
      agreement between the Company and Dor Alon for the establishment of a
      joint loyalty club for the benefit of the customers of the Company and Dor
      Alon under the brand name “YOU” (hereinafter - the Loyalty Program) that
      has been incorporated as a partnership of the Company (75%) and Dor Alon
      (25%) (hereinafter - the Customers’
Club).


The
Customer's club partially finances its activities through the annual member's
fees collected. The excess of the expenses incurred over the revenues collected
is charged against the partners, in each period, partly in accordance with their
relative share in the partnership, and partly based on their customers’ share in
the relative benefit being utilized. Based on the above, the Company’s share in
this Customer's club results is zero; the amounts allocated and charged by the
partnership are classified among the relative income statements line items based
on their nature.





2.
              The
      agreement of the Company and Dor Alon with Diners Israel prescribes that
      the members of the Customers’ Club will receive a Diners credit card, and
      defines the cooperation between the customers’ club and Diners, and
      includes accompanying agreements to the said
  agreement.
  F-77
  BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 32 – COMMITMENTS(continued):





The
      agreement determines, among other things, the division of costs between
      the partnership and Diners in respect of the costs of attracting new
      customers to the loyalty program, mailing and advertising costs including
      the participation of Diners in the advertising budget of the loyalty
      program, and clearing fees.





c.
              Some
      of the stores that are operated by the Company are leased under
      non-cancelable long-term operating leases, mostly with renewal options.
      Future minimum payments under non-cancelable operating leases for the
      years are as follows:





December
      312007
                        
                        
                        2008NIS
      in thousandsFirst
      year
                        
                        
                        148,637
                        
                        
                        
                        171,055Second
      year
                        
                        
                        147,036
                        
                        
                        
                        170,293Third
      year
                        
                        
                        160,988
                        
                        
                        
                        151,656Fourth
      year
                        
                        
                        115,646
                        
                        
                        
                        140,542Fifth
      year
                        
                        
                        106,962
                        
                        
                        
                        110,045Sixth
      year and thereafter
                        
                        
                        313,941
                        
                        
                        
                        286,886993,210
                        
                        
                        
                        1,030,477





d.
              Capital
      commitments





Capital
expenditure contracted for at the balance sheet date but not yet incurred is as
follows:





December
      31,2007
                      
                      
                      2008NIS
      in thousandsProperty,
      plant and equipment
                      
                      
                      71,097
                      
                      
                      
                      35,764





e.
              Operating
      lease commitments - the Company leases various retail outlets, offices and
      warehouses under non-cancellable operating lease
    agreements.





The lease
terms are between five and 10 years, and the majority of lease agreements are
renewable at the end of the lease period at market rate. The Company leases cars
under cancellable operating lease agreements. The Company is required to give up
to two month notice for the termination of these agreements.





NOTE
33 - LIENS AND GUARANTEES:





a.
              Liens
      for liabilities to banks, a proportionately consolidated Company has
      registered fixed charges on its land, goodwill, rights to insurance and
      share capital and floating charge on rent income. As of December 31, 2008,
      the proportionately consolidated Company has liabilities to banks in the
      amount of NIS 10 million.





b.
              The
      Bee Group and some of its investee companies (excluding Na'aman and
      Vardinon) placed unlimited, fixed and floating charges and a first ranking
      lien on the warehouse and all its assets, property, book debts, rent,
      goodwill, profits, revenues, rights of ownership and other benefits in
      favor of banks to secure their liabilities to the banks, amounting as of
      December 31, 2008 to NIS 174
million.




F-78




BLUE
SQUARE – ISRAEL LTD.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE 33 - LIENS AND GUARANTEES(continued):





In order
to secure the liabilities of Na’aman and Vardinon, the companies have undertaken
not to pledge any of their assets and/or provide any kind of guarantee to a
third party without first addressing the banks.





As of
December 31, 2008 there are charges on five of the transferred properties to
BSRE for the purpose of securing the liabilities of the vendors of the above
properties acquired by the Company vis-à-vis third parties (mainly banks). In
addition, such charges have been registered on twelve further properties from
among the properties transferred. In the latter case, however, the Company has
received ‘exclusion letters’ (hereinafter - the conditional ‘exclusion letters’)
from the holders of the above charges. The Company has advised BSRE, that it has
abided by, or will abide by, the terms of the conditional ‘exclusion letters,’
and that there is no significant impediment to the completion of their transfer
to BSRE.





GUARANTEES





a.
            The
      Company has provided bank guarntees for a third party such as service
      suppliers and customers in an aggregate amount of approximately NIS 4.2
      million.





b.
            BSRE
      has provided bank guarntees for a third party in an aggregate amount of
      approximately NIS 0.5 million.





c.
            BSIP
      has provided bank guarntee for a third party in amount of approximately
      NIS 0.7 million. A subsidiary (Hyper Hyper) has provided bank guarntee for
      a third party in amount of approximately NIS 1.4
  million.





d.
            As
      of balance sheet date, Bee Group has provided guarntees for a third party
      in amount of approximately NIS 67 thousands. Moreover, the other
      shareholder in investee Company in Bee Group has provided an unlimited
      guarantee for a bank in respect of loans of the investee Company in the
      amount of approximately NIS 34
million.





NOTE
34 – RELATED-PARTY TRANSACTION:





"Related
      Parties" – As defined in IAS 24 – 'Related Party
    Disclosures."





Key
      management personnel – included together with other entities in the said
      definition of "related parties" in IAS 24, include the members of the
      board of directors and senior managers in the
  Company.





Goods
      and services are bought from associates and an entity controlled by key
      management personnel, in the normal course of business and under normal
      trade terms.The
      principal related  parties of the Company are, among others:
      Alon Retail Ltd., Alon Israel Oil Company Ltd., Bee Group, Bielsol
      Investments (1987) Ltd. Granot - Agricultural Cooperative Society -
      Kibbutz Purchasing Organization, Dor Alon Energy in Israel (1988) Ltd.,
      M.B.I.S.F. Holdings Ltd., Dor Food Chains Holdings Ltd., Africa Israel
      Ltd., and many other companies,  whose interests are controlled
      by the Company's directors among
others.




F-79




NOTE 34 – RELATED-PARTY TRANSACTION(continued):





Transactions
      with related parties:





Year
      ended December 312007
                    
                    
                    2008Directors'
      fees
                    
                    
                    1,032
                    
                    
                    
                    1,709Legal
      consulting
                    
                    
                    1,282
                    
                    
                    
                    1,775Commissions
      (1)
                    
                    
                    (3,597
                    )
                    
                    
                    (5,743
                    )Discounts
      (2)
                    
                    
                    716
                    
                    
                    
                    924





1)
              In
      January 2004 the shareholders of the Company approved an agreement
      according to which the Company will provide to related parties purchasing
      and supply services for stores operated by the related parties. In
      consideration for these services, the Company is entitled to payment
      equivalent to the cost of the services provided with the addition of a
      margin as stated in the
agreement.





2)
                On
      September 13, 2005, the Company’s general shareholders meeting approved a
      discount arrangement for some of the employees of the companies holding
      directly or indirectly in the Company’s shares (some of the employees of
      Alon Group, Palace Candles Group, Africa-Israel Group and Ikea Group)
      (hereinafter - “the entitled employees”).

                    The
      discounts to be given to the entitled employees will be identical to those
      given to the Company’s employees, which during 2008 were: 9% at the Mega
      In Town stores, 9% at the Mega stores and 4% at the Shefa Shuk stores.
      Since the launch of the Mega Bool stores in December 2008, the discounts
      for employees at the Mega Bool stores and Shefa Shuk stores is
      6%.
                    The discounts are limited to purchases in a total amount of
      NIS 7,000 a month.




As to
agreement signed with Dor Alon in connection with the purchase of Diners Israel
and establishing a joint customer club, see note 32b.





Key
management compensation





The
compensation paid or payable to key management (executive and non-executive),
members of the Executive Committee, the Company Secretary and the Head of
Internal Audit for employee services is shown below:





Year
      ended December 31,2007
                      
                      
                      2008NIS
      in thousandsSalaries
      and other short-term employee benefits
                      
                      
                      17,071
                      
                      
                      
                      17,539Long-term
      employee benefits
                      
                      
                      957
                      
                      
                      
                      1,401Share-based
      payments
                      
                      
                      -
                      
                      
                      
                      3,97718,028
                      
                      
                      
                      22,917





F-80




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 34 – RELATED-PARTY TRANSACTION(continued):





Year-end
balances arising from sales/purchases of goods/services:





December 31,2007
                  
                  
                  2008NIS in thousandsTrade
      receivables (note 10b):
                  
                  
                  42,771
                  
                  
                  
                  56,550Other
      receivables (note 13b):
                  
                  
                  20,378
                  
                  
                  
                  8,10463,149
                  
                  
                  
                  64,654





The
receivables from related parties arise mainly from sale transactions and are due
two months after the date of sales. The receivables are unsecured in nature and
bear no interest. There are no provisions held against receivables from related
parties (2007: nil).





NOTE
35 – EVENTS AFTER BALANCE SHEET DATE:





On
December 30, 2008, the Board of Directors of Blue Square has approved a
reorganization of the Company's retail activities and is examining a suggested
reorganization of its real estate activities. As part of the retail activities
reorganization, the retail activities would be centralized in Blue Square's
wholly owned subsidiary, BSIP. As part of the real estate activities
reorganization, further to the transfer of real estate assets by the Company to
its subsidiary BSRE and the IPO of BSRE (now held 78.45% by the Company)
performed in 2006, the Company now considers the transfer of real estate assets
held by BSIP and its subsidiaries to BSRE, so that real estate activities would
be centralized in BSRE.





Retail
Activities: The retail activities of the Company would be centralized in BSIP
pursuant to (i) an agreement for the transfer of some of the intangible assets
related to the retail activities from the Company to BSIP as a tax exempt
transaction pursuant to the Israeli Income Tax Ordinance [New Version] and (ii)
an agreement for the transfer of the other assets and liabilities of the retail
activities from the Company to BSIP primarily on the basis of their book value
as reflected in the financial statements of the Company.





In
addition, as part of the reorganization of the retail activities, BSIP will
merge with its wholly owned subsidiary, The Blue Square Chain (Hyper Hyper) Ltd.
("Hyper Hyper"), as a tax exempt transaction pursuant to the Israeli Income Tax
Ordinance [New Version]. As a result of this transaction, all of the retail
activity of Hyper Hyper will be transferred to BSIP.





In
January 2009, Blue Square's board of directors approved a reorganization of its
real estate activities pursuant to which Blue Square's wholly-owned subsidiary,
BSIP, would transfer all of the real estate held by it to BSRE.  On
February 18, 2009, BSRE's shareholders approved the transaction.





As part
of the approved transaction, all real estate property (and related leases) held
by BSIP and BSIP's subsidiaries would be transferred to BSRE.  All
real estate property used by BSIP prior to the transfer would be leased back by
BSRE to BSIP for its retail activities under terms similar to existing lease
agreements between BSRE and BSIP and existing lease agreements between BSRE and
Blue Square that were previously transferred to BSIP, as described below. The
periods of the existing lease agreements would be extended to match the period
of the new lease agreement, i.e., 10 years from the transfer of the BSIP real
estate assets to BSRE, with an additional option period of five years
exercisable by BSIP.





F-81




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 35 – EVENTS AFTER BALANCE SHEET
DATE(continued):





The lease
agreements between BSRE and BSIP would contain terms similar to the existing
lease agreements, which provide for annual rent for property used for
supermarkets to be the higher of 2% of the annual turnover of that store or 9%
of the amount paid by BSRE to purchase the underlying real estate of that store
(excluding consideration paid for certain unused building rights), plus amounts
invested by BSRE in the asset, reduced by certain costs and payments and
increased according  to Israel’s CPI. The annual rent for property not
used for stores would be equal to 9% of the amount paid by BSRE, linked to
increases in Israel’s CPI.





The
sale of BSIP's real estate property (and related leases) to BSRE would be for an
aggregate consideration of approximately NIS 464 million, based on an appraisal
by an independent appraiser. BSRE plans to finance 50% of the consideration from
its existing sources and 50% by a financial institution. In the event BSRE does
not obtain the required financing prior to closing of the transaction, BSRE will
be entitled to postpone payment of up to NIS 200 million of the consideration
until April 1, 2010, during which time this amount will bear interest at 7% per
annum and be linked to the Israeli consumer price index. The transaction is
subject to various taxes and levies according to Israeli law which are under
examination by the BSRE and its advisors.





As a
result of ongoing discussions between BSIP and BSRE and the Israeli Tax
Authority regarding the structure of the real estate reorganization, BSRE's
board of directors may amend the terms of the transaction up to August 19, 2009,
and such amendment will be subject to BSRE shareholder approval, if it is
material.  If BSRE's board of directors does not amend the terms of
the transaction by August 19, 2009, or if the amended terms of the transaction
are not approved by BSRE's shareholders, then the transaction will be effected
according to the original terms of the transaction.





NOTE
36 – DISCLOSURE REGARDING THE ADOPTION OF IFRS :





a.
              The
      following adjustments relate to the effect of the transition to reporting
      under IFRS, as do the explanations with respect to these adjustments and
      with respect to the exemptions that the Company has elected to apply upon
      the transition to the IFRS reporting. The adjustments are presented as
      follows:





1.
              Adjustments
      to the consolidated balance sheets as of January 1, 2007 ("the opening
      balance") and December 31,
2007;





2.
            Adjustments
      to the consolidated income statements of operations for the year ended
      December 31, 2007;





3.
            Adjustments
      to certain equity items as of January 1, 2007 and December 31,
      2007;





4.
            The
      provision of explanations with respect to the above adjustments, together
      with a description of the exemptions adopted by the Company under IFRS 1
      during the course of the transition to the IFRS reporting
  .





F-82




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):





Following is the
      exemptionelected by
      the Company pursuant to IFRS 1, which have not been retrospectively
      adopted on the transition date to
IFRS:





Business
      combinations





The Company has not
      retrospectively adopted IFRS 3, "Business Combinations", and accordingly,
      goodwill and excess of cost arising in business combinations which
      occurred prior to January 1, 2007 and relating to the acquisition of
      subsidiaries, associates and jointly controlled entities are not accounted
      for according to IFRS 3 but rather presented as previously accounted for
      under Israeli GAAP.





1.
            The
      effect of transition on the consolidated balance sheets as
      of  January 1, 2007 and December 31,
  2007:




January 1, 2007
                                                                                                
                                                                                                December 31, 2007Reporting
                                                                                                  under
                                                                                                  Israeli
                                                                                                  GAAP
                                                                                                
                                                                                                Effect of
                                                                                                  transition
                                                                                                  to IFRS
                                                                                                
                                                                                                Reporting
                                                                                                  underIFRS
                                                                                                
                                                                                                Reporting
                                                                                                  under
                                                                                                  Israeli
                                                                                                  GAAP
                                                                                                
                                                                                                Effect of
                                                                                                  transition
                                                                                                  to IFRS
                                                                                                
                                                                                                Reporting
                                                                                                    under
                                                                                                    IFRSNote
                                                                                                
                                                                                                NIS in thousandsASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                186,454
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                186,454
                                                                                                
                                                                                                
                                                                                                56,410
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                56,410Marketable
      securities
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                65,287
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                65,287
                                                                                                
                                                                                                
                                                                                                199,394
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                199,394Short-term
      bank deposit
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                526,459
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                526,459
                                                                                                
                                                                                                
                                                                                                103,498
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                103,498Trade
      receivables
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                672,605
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                672,605
                                                                                                
                                                                                                
                                                                                                776,251
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                776,251Other
      accounts receivable
                                                                                                
                                                                                                3,
      12
                                                                                                
                                                                                                
                                                                                                119,028
                                                                                                
                                                                                                
                                                                                                (43,181
                                                                                                )
                                                                                                
                                                                                                75,847
                                                                                                
                                                                                                
                                                                                                139,650
                                                                                                
                                                                                                
                                                                                                (39,809
                                                                                                )
                                                                                                
                                                                                                99,841Income
      taxes receivable
                                                                                                
                                                                                                12
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                26,175
                                                                                                
                                                                                                
                                                                                                26,175
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                23,062
                                                                                                
                                                                                                
                                                                                                23,062Inventories
                                                                                                
                                                                                                1
                                                                                                
                                                                                                
                                                                                                377,561
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                377,561
                                                                                                
                                                                                                
                                                                                                453,655
                                                                                                
                                                                                                
                                                                                                289
                                                                                                
                                                                                                
                                                                                                453,944Total
      current assets
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                1,947,394
                                                                                                
                                                                                                
                                                                                                (17,006
                                                                                                )
                                                                                                
                                                                                                1,930,388
                                                                                                
                                                                                                
                                                                                                1,728,858
                                                                                                
                                                                                                
                                                                                                (16,458
                                                                                                )
                                                                                                
                                                                                                1,712,400NON-CURRENT
      ASSETS:Associated
      companies
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                4,762
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                4,762
                                                                                                
                                                                                                
                                                                                                4,948
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                4,948Derivatives
      financial instruments
                                                                                                
                                                                                                8
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                10,500
                                                                                                
                                                                                                
                                                                                                10,500Prepaid
      expenses in respect  of operating lease
                                                                                                
                                                                                                2
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                205,670
                                                                                                
                                                                                                
                                                                                                205,670
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                199,679
                                                                                                
                                                                                                
                                                                                                199,679Other
      long-term receivables
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                2,618
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                2,618
                                                                                                
                                                                                                
                                                                                                48,289
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                48,289Property,
      plant and equipment,  net of accumulated
      depreciation  and amortization
                                                                                                
                                                                                                2
                                                                                                
                                                                                                
                                                                                                1,778,361
                                                                                                
                                                                                                
                                                                                                (246,688
                                                                                                )
                                                                                                
                                                                                                1,531,673
                                                                                                
                                                                                                
                                                                                                1,860,203
                                                                                                
                                                                                                
                                                                                                (246,688
                                                                                                )
                                                                                                
                                                                                                1,613,515Investment
      property
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                298,026
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                298,026
                                                                                                
                                                                                                
                                                                                                315,778
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                315,778Intangible
      assets charges, net of accumulated amortization
                                                                                                
                                                                                                1,14
                                                                                                
                                                                                                
                                                                                                99,752
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                99,752
                                                                                                
                                                                                                
                                                                                                251,994
                                                                                                
                                                                                                
                                                                                                28,426
                                                                                                
                                                                                                
                                                                                                280,420Deferred
      taxes
                                                                                                
                                                                                                1,2,3,6,9
                                                                                                
                                                                                                
                                                                                                16,789
                                                                                                
                                                                                                
                                                                                                15,733
                                                                                                
                                                                                                
                                                                                                32,522
                                                                                                
                                                                                                
                                                                                                22,301
                                                                                                
                                                                                                
                                                                                                11,241
                                                                                                
                                                                                                
                                                                                                33,542Total
      non-current assets
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                2,200,308
                                                                                                
                                                                                                
                                                                                                (25,285
                                                                                                )
                                                                                                
                                                                                                2,175,023
                                                                                                
                                                                                                
                                                                                                2,503,513
                                                                                                
                                                                                                
                                                                                                3,158
                                                                                                
                                                                                                
                                                                                                2,506,671Total
      assets
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                4,147,702
                                                                                                
                                                                                                
                                                                                                (42,291
                                                                                                )
                                                                                                
                                                                                                4,105,411
                                                                                                
                                                                                                
                                                                                                4,232,371
                                                                                                
                                                                                                
                                                                                                (13,300
                                                                                                )
                                                                                                
                                                                                                4,219,071





F-83




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):


January 1, 2007
                                                                                                                                                                          
                                                                                                                                                                          December 31, 2007Reporting
                                                                                                                                                                            under
                                                                                                                                                                            Israeli
                                                                                                                                                                            GAAP
                                                                                                                                                                          
                                                                                                                                                                          Effect of
                                                                                                                                                                            transition
                                                                                                                                                                            to IFRS
                                                                                                                                                                          
                                                                                                                                                                          Reporting
                                                                                                                                                                            under
                                                                                                                                                                            IFRS
                                                                                                                                                                          
                                                                                                                                                                          Reporting
                                                                                                                                                                            under
                                                                                                                                                                            Israeli
                                                                                                                                                                            GAAP
                                                                                                                                                                          
                                                                                                                                                                          Effect of
                                                                                                                                                                            transition
                                                                                                                                                                            to IFRS
                                                                                                                                                                          
                                                                                                                                                                          Reporting
                                                                                                                                                                              under
                                                                                                                                                                              IFRSNote
                                                                                                                                                                          
                                                                                                                                                                          NIS in thousandsLIABILITIES
      SHAREHOLDERS' AND EQUITYCURRENT
      LIABILITIES:Credit
      and loans from banks and others
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          13
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          211,152
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          211,152
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          137,864
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          33,146
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          171,010Current
      maturities of debentures and convertible debentures
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          4
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          53,706
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          55,307
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          109,013
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          69,859
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          69,859Trade
      payables
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          938,007
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          938,007
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *973,461
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *973,461Other
      accounts payable and accrued expenses
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,12
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          409,153
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,549
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          411,702
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *447,230
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          499
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *447,729Income
      taxes payable
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          12
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,905
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,905Total
      current liabilities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,612,018
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          57,856
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,669,874
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,628,414
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          36,550
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,664,964NON-CURRENT
      LIABILITIES:Long-term
      loans from banks, net of current maturities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          13
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          112,574
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          112,574
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          281,634
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (33,146
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          248,488Convertible
      debentures, net of current maturities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          4
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          214,794
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *117,922
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *332,716
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          143,158
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *50,548
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *193,706Debentures,
      net of current maturities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          827,558
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *(22,014
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          *805,544
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          772,827
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          *(23,809
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          *749,018Other
      liabilities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,746
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,746
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          11,646
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          11,646Derivatives
      financial instruments
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,14
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,558
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,558
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,968
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          9,968Liabilities
      for employee rights, net of amount funded
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          6
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          35,527
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (2,819
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          32,708
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          43,909
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (7,923
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          35,986Deferred
      tax
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,3,6
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          40,173
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,034
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          42,207
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          51,638
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          5,977
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          57,615Total
      non-current liabilities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,240,372
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          104,681
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,345,053
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,304,812
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,615
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,306,427Total
      liabilities
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,852,390
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          162,537
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          3,014,927
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,933,226
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          38,165
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          2,971,391MINORITY
      INTEREST
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          251,792
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (251,792
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          274,311
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (274,311
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          -SHAREHOLDERS'
      EQUITY:Equity
      attributable to equity holders of the Company:Ordinary
      shares
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          53,414
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          53,414
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          57,094
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          57,094Additional
      paid-in capital
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          4
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          737,756
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          28,653
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          766,409
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          845,168
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          173,237
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,018,405Other
      reserves
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          6,8
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,415
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,415Retained
      earnings (Accumulated deficit)
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          192,350
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (162,811
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          29,539
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          122,572
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (229,834
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          (107,262
                                                                                                                                                                          )Dividend
      declared subsequent to balance sheet date
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          10
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          60,000
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (60,000
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -1,043,520
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (194,158
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          849,362
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,024,834
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (55,182
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          969,652MINORITY
      INTEREST IN EQUITY
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          241,122
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          241,122
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          -
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          278,028
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          278,028Total
      equity
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,043,520
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          46,964
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,090,484
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,024,834
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          222,846
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          1,247,680Total
      liabilities and shareholders' equity
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          4,147,702
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (42,291
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          4,105,411
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          4,232,371
                                                                                                                                                                          
                                                                                                                                                                          
                                                                                                                                                                          (13,300
                                                                                                                                                                          )
                                                                                                                                                                          
                                                                                                                                                                          4,219,071





* Reclassified.





F-84




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE
36 – DISCLOSURE REGARDING THE ADOPTION OF IFRS (continued):





2.
            Reconciliation
      of income statement reported under Israeli GAAP to reporting under
      IFRS:





Year ended December 31, 2007Reporting
                          under
                          Israeli
                          GAAP
                        
                        
                        Effect of
                          transition
                          to IFRS
                        
                        
                        Reporting under
                          IFRSNote
                        
                        
                        NIS in thousandsSales
                        
                        
                        9
                        
                        
                        
                        6,982,350
                        
                        
                        
                        (366
                        )
                        
                        
                        6,981,984Cost
      of sales
                        
                        
                        6
                        
                        
                        
                        5,129,520
                        
                        
                        
                        58
                        
                        
                        
                        5,129,578Gross
      profit
                        
                        
                        
                        
                        
                        
                        1,852,830
                        
                        
                        
                        (424
                        )
                        
                        
                        1,852,406Selling,
      general and administrative expenses
                        
                        
                        1,2,6,9,11
                        
                        
                        
                        1,562,555
                        
                        
                        
                        653
                        
                        
                        
                        1,563,208Operating
      profit before net gain from adjustment of investment property to fair
      value and other expenses and income
                        
                        
                        
                        
                        
                        
                        290,275
                        
                        
                        
                        (1,077
                        )
                        
                        
                        289,198Other
      income
                        
                        
                        11
                        
                        
                        
                        3,355
                        
                        
                        
                        12,480
                        
                        
                        
                        15,835Other
      expenses
                        
                        
                        11
                        
                        
                        
                        -
                        
                        
                        
                        (12,755
                        )
                        
                        
                        (12,755
                        )Net
      gain from adjustment of investment property to fair value
                        
                        
                        
                        
                        
                        
                        10,456
                        
                        
                        
                        -
                        
                        
                        
                        10,456Operating
      income
                        
                        
                        
                        
                        
                        
                        304,086
                        
                        
                        
                        (1,352
                        )
                        
                        
                        302,734Finance
      income
                        
                        
                        4,7,8,9
                        
                        
                        
                        -
                        
                        
                        
                        60,978
                        
                        
                        
                        60,978Finance
      expenses
                        
                        
                        4,7,8,9
                        
                        
                        
                        54,798
                        
                        
                        
                        63,499
                        
                        
                        
                        118,297Share
      in profit (losses) of associated companies, net
                        
                        
                        
                        
                        
                        
                        -
                        
                        
                        
                        186
                        
                        
                        
                        186Income
      before taxes on income
                        
                        
                        
                        
                        
                        
                        249,288
                        
                        
                        
                        (3,687
                        )
                        
                        
                        245,601Taxes
      on income
                        
                        
                        1-3,5,6,8,9
                        
                        
                        
                        68,495
                        
                        
                        
                        1,284
                        
                        
                        
                        69,779Income
      after taxes on income
                        
                        
                        
                        
                        
                        
                        180,793
                        
                        
                        
                        (4,971
                        )
                        
                        
                        175,822Share
      in profit (losses) of associated companies, net
                        
                        
                        
                        
                        
                        
                        186
                        
                        
                        
                        (186
                        )
                        
                        
                        -Minority
      interest in profit of subsidiaries, net
                        
                        
                        
                        
                        
                        
                        30,757
                        
                        
                        
                        (30,757
                        )
                        
                        
                        -Net
      income
                        
                        
                        
                        
                        
                        
                        150,222
                        
                        
                        
                        25,600
                        
                        
                        
                        175,822Attributable
      to:Equity
      holders of the parent
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        143,628Minority
      interests
                        
                        
                        1b
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        32,194175,822Net  income
      per Ordinary share attributed to Company shareholders or
    ADS:
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        175,822Basic
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3.39Fully
      diluted
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3.39





F-85




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):





b)
            Effect
      of transition on certain equity
items:





(a)
            Additional
      paid-in capital:





Explanation
                  
                  
                  NIS in thousandsBalance
      as presented at January 1, 2007 in accordance with Israeli
      GAAP
                  
                  
                  
                  
                  
                  737,756Adjustments
      due to reclassification ofissuance
      of package of securities
                  
                  
                  1
                  
                  
                  
                  28,653Balance
      at January 1, 2007 in accordance with IFRS
                  
                  
                  
                  
                  
                  
                  766,409Balance
      as presented at December 31, 2007 inaccordance
      with Israeli GAAP
                  
                  
                  
                  
                  
                  
                  845,168Adjustments
      due to reclassification ofissuance
      of package of securities
                  
                  
                  4
                  
                  
                  
                  173,237Balance
      at December 31, 2007 in accordance with IFRS
                  
                  
                  
                  
                  
                  
                  1,018,405





(b)
            Retained
      earnings (accumulated deficit):





Explanation
                  
                  
                  NIS in thousandsBalance
      as presented at January 1, 2007 in accordance with Israel
    GAAP
                  
                  
                  
                  
                  
                  192,350Adjustments
      in respect of employee benefits net of income taxes
                  
                  
                  6
                  
                  
                  
                  1,745Adjustments
      due to leasehold rights amortization from the Israel Land
      Administration
                  
                  
                  2
                  
                  
                  
                  (22,863
                  )Adjustment
      due to revaluation of derivatives and embedded derivates to fair
      value
                  
                  
                  9
                  
                  
                  
                  (5,735
                  )Adjustments
      due to conversion option in convertible debentures
                  
                  
                  4
                  
                  
                  
                  (175,404
                  )Deferred
      income taxes
                  
                  
                  3
                  
                  
                  
                  (9,096
                  )Adjustments
      due to Provision for liabilities
                  
                  
                  5
                  
                  
                  
                  (2,039
                  )Adjustments
      due to Fair value on acquisition Attributed to leased land
                  
                  
                  2
                  
                  
                  
                  (6,054
                  )Adjustment
      due to reallocation of proceeds of shares and debentures issued by a
      subsidiary
                  
                  
                  1
                  
                  
                  
                  (3,360
                  )Adjustment
      due to dividend declared subsequent to balance sheet date
                  
                  
                  10
                  
                  
                  
                  60,000Balance
      at January 1, 2007 in accordance with IFRS
                  
                  
                  
                  
                  
                  
                  29,539





F-86




BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):





(b)
            Retained
      earnings (accumulated deficit)
(continued):




Explanation
                  
                  
                  NIS
      in thousandsBalance
      as presented at December 31, 2007 in accordance with Israel
      GAAP
                  
                  
                  
                  
                  
                  122,572Adjustments
      due to liabilities in respect of employee benefits net of income
      taxes
                  
                  
                  6
                  
                  
                  
                  5,587Adjustment
      due to revaluation of derivatives and embedded derivates to fair
      value
                  
                  
                  9
                  
                  
                  
                  (5,075
                  )Adjustment
      due to deferred income taxes
                  
                  
                  3
                  
                  
                  
                  (8,764
                  )Adjustment
      due to reclassification of revaluation of available-for-sale financial
      assets
                  
                  
                  8a
                  
                  
                  
                  (1,262
                  )Adjustment
      due to provision for liabilities
                  
                  
                  5
                  
                  
                  
                  (2,392
                  )Adjustment
      due to reallocation of proceeds of convertible debentures issued by a
      subsidiary
                  
                  
                  1
                  
                  
                  
                  (3,360
                  )Adjustments
      due to leasehold rights amortization from the Israel Land
      Administration
                  
                  
                  2
                  
                  
                  
                  (26,299
                  )Adjustments
      due to fair value on acquisition attributed to leased land
                  
                  
                  2
                  
                  
                  
                  (6,257
                  )Adjustments
      due to derivative financial instrument in the Diners
      transaction
                  
                  
                  8b
                  
                  
                  
                  7,875Adjustments
      due to conversion option in convertible debentures
                  
                  
                  4
                  
                  
                  
                  (189,886
                  )Balance
      at December 31, 2007 in accordance with IFRS
                  
                  
                  
                  
                  
                  
                  (107,262
                  )





(c)
            Other
      reserves:





Explanation
                  
                  
                  NIS in thousandsBalance
      as presented at December 31, 2007 in accordance with Israeli
      GAAP
                  
                  
                  
                  
                  
                  -Adjustment
      due to reclassification of revaluation of available-for-sale financial
      assets
                  
                  
                  8
                  
                  
                  
                  1,415Balance
      at December 31, 2007 in accordance with IFRS
                  
                  
                  
                  
                  
                  
                  1,415





F-87


BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 4.
              Notes
      to the effect of  transition to the balance sheets as of January
      1, 2007 ("the opening balance") and December 31, 2007 and to the
      statements of operations for the year ended December 31, 2007 from Israeli
      GAAP to IFRS:
 
 1)
              Business
      combinations:
 
 a)
              According
      to Israeli GAAP, minority interest arising in the acquisition of a
      subsidiary is calculated based on the carrying amount of the subsidiary's
      assets and liabilities.
 
 According
      to the provisions of IFRS 3, "Business Combinations", the Company
      recognizes minority interest on the date of acquisition based on the
      minority's share of the fair value of the subsidiary's assets and
      liabilities on the date of acquisition with a corresponding presentation
      of these assets and liabilities in the balance sheet at their full fair
      value. Goodwill arising on the date of acquisition will continue to be
      calculated based on the difference between the cost of acquisition and the
      Company's share of the fair value of the subsidiary's net assets, as
      calculated according to Israeli
GAAP.
 
 b)
              According
      to Israeli GAAP, minority interest is presented in the balance sheet as a
      line item between liabilities and shareholders' equity and in the
      consolidated statement of operation as an expense in determining the
      Company's consolidated net income. Pursuant to IAS 1, "Presentation of
      Financial Statements", the Company presents minority interest in the
      consolidated balance sheet within equity and minority interest is not
      deducted from the Company's net
income.
 
 2)
              Leasehold
      rights mainly from the Israel Land Administration
  (ILA):
 
 Under
      Israeli GAAP, leased land (mainly from the Israel Land Administration) is
      classified as property, plant and equipment and is not
      depreciated.
 
 Under
      IFRS, such land is not considered to be owned by the Company and the lease
      payments are classified as prepaid expenses and amortized over the term of
      the lease, including the period for which the Company has an option to
      continue the lease if at the inception of the lease it was reasonably
      certain that the option would be
exercised.
 
 3)
              Deferred
      taxes:
 
 a)
              According
      to Israeli GAAP, there is no requirement to record deferred taxes in
      respect of temporary differences (as of January 1, 2007) in respect of
      land and buildings that are depreciated over a period in excess of 20
      years. In addition, there is no requirement to create deferred taxes in
      respect of land and land originating in business combination transactions
      accrued prior to January 1, 2005. Upon the transition to IFRS and
      according to IAS 12, "Income Taxes", the Company recorded deferred tax
      liability in respect of these temporary
  differences.
 
 b)
              According
      to Israeli GAAP, part of the deferred taxes were presented among current
      assets under other accounts receivable. Upon the transition to IFRS and
      according to IAS 12, "Income Taxes", these deferred taxes are presented
      among non-current assets.
  F-88
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 4)
              Convertible
      debentures and attribution of proceeds from unit
  issuance:
 
 a)
              Unit
      issuance:
 
 According
      to Israeli GAAP, based on the provisions of Accounting Standard No. 22 of
      the Israeli ASB, upon the issuance by a subsidiary of a unit of shares,
      debentures and convertible debentures, in August 2006, the Company split
      the proceeds from the issuance based on the relative fair value of the
      components in the unit.
 
 Upon
      the transition to IFRS, according to IAS 32, "Financial Instruments -
      Presentation", upon the issuance of a unit, the proceeds from the issuance
      are attributed first to financial liabilities measured periodically at
      fair value, then to financial liabilities measured only upon initial
      recognition at fair value and the balance (residual amount) is attributed
      to the component that is considered an equity
  instrument.
 
 In
      addition, according to IFRS, the portion of issuance expenses,
      attributable to shares that are outstanding prior to a public offering and
      that are registered for trading on the date of the offering simultaneously
      with the new shares, are recorded in the income statement on the date of
      issuance whereas according to Israeli GAAP, these issuance expenses were
      not attributed separately.
 
 b)
                Convertible
      debentures:
 
 The
      Company, has debentures outstanding that are convertible into ordinary
      shares of the Company or the subsidiaries whose conversion price is linked
      to the Israeli CPI. According to the transition provisions of Accounting
      Standard No. 22 of the Israel Accounting Standards Board, "Financial
      Instruments: Disclosure and Presentation" ("Accounting Standard No. 22"),
      these debentures represent a compound financial instrument that includes a
      liability component and an equity component. Accordingly, the proceeds
      received from the issuance of the debentures were split into these
      components according to the provisions of Accounting Standard No.
      22.
 
 According
      to IAS 32, "Financial Instruments - Presentation", since the convertible
      debenture is linked to the Israeli CPI and is not fixed in NIS terms (the
      Company's functional currency), the conversion component is a financial
      liability and not an equity instrument. The conversion component is
      measured according to IAS 39, "Financial Instruments - Recognition and
      Measurement", based on its fair value, and changes in each period in the
      fair value of this component are included as financial expenses or
      income.
 
 Subsequently,
      at each balance sheet date, the components of the convertible debentures
      are accounted for separately. The conversion component is recorded at fair
      value and the liability component is recorded using the amortized cost
      method based on the effective interest rate computed at date of initial
      recognition.
  F-89
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 Accordingly,
      upon transition to reporting under IFRS, on January 1, 2007, the amount
      presented as a financial liability in respect of the said debentures has
      been adjusted to reflect the effects of the
  following:
 
 (1)
              The
      fair value of the conversion component as of January 1,
    2007.
 
 (2)
              The
      balance of the liability component (the debt instrument) as it would have
      been presented on January 1, 2007, had the issuance proceeds in August
      2006 been allocated first to the fair value of the conversion component,
      and the residual amount had been allocated to the liability component, and
      subsequently, the liability component had been accounted for using
      amortized cost (based on the recalculated effective interest
      rate).
 
 5)
              Provisions
      for liabilities:
 
 According
      to Israeli GAAP, the Company recognizes provisions for liabilities if it
      is probable that there will be an outflow of the Company's resources to
      settle the liability.
 
 According
      to IAS 37, "Provisions, Contingent Liabilities and Contingent Assets", the
      Company recognized a provision in respect of those claims for which it is
      more likely than not that there will be an outflow of the Company
      resources to settle the liability.
  6)
              Employee
      benefits:
 According
      to Israeli GAAP, the severance pay liability is measured based on the
      employee's latest monthly salary multiplied by the number of years of
      employment as of each balance sheet date, based on the "shut down" method,
      and severance pay funds are measured at their redemption value at each
      balance sheet date.
                    
                    According
      to IAS 19, "Employee Benefits", the Company's benefit plan is considered a
      defined benefit plan, and therefore, the severance pay liability is
      required to be calculated on an actuarial basis. The actuarial calculation
      takes into consideration future salary increases, the rates of employee
      turnover, and the estimated timing of payments.
                    
                    The
      amounts are presented based on expected future cash flows discounted at a
      rate determined by reference to high quality government bonds denominated
      in NIS whose maturities approximate the term of the severance pay
      liability.
                    
                    Employee
      benefit plan assets are measured at fair value.
                    
                    According
      to IAS 19, the Company elected the approach according to which the
      actuarial gains and losses (from changes in actuarial assumptions) are
      taken to retained
earnings.
 
 7)
              Financial
      income and expenses:
 
 According
to Israeli GAAP, financial income and expenses are presented net in the
statement of operation. According to IFRS, financial income should be disclosed
separately from financial expenses in the income statement and accordingly, the
Company separately presented financial expenses and income.
  F-90
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 8)
              Financial
      instruments:
 
 a)
              Investments
      in marketable securities:
 
 According
      to Israeli GAAP, the Company classified its investments in marketable
      securities as short-term investments. Accordingly, these investments were
      presented at fair value.
 
 Pursuant
      the provisions of IAS 39 - “Financial Instruments: Recognition and
      Measurement” the Company will classify its investments in the said
      securities as “available-for-sale financial assets” or as securities "held
      for trading".  In accordance with IAS 39, these financial
      assets will be presented at their fair value at each balance sheet date.
      Changes in fair value of available for sale securities will be charged to
      equity, except for impairment, and when applicable, expect for interest
      expenses and exchange rate differences, which will be charged to the
      statement of operation.  Changes in the fair value of securities
      held for trading would be recorded as financial income
      (expenses).
 
 b)
              Acquisition
      of Diners shares
  According
      to Israeli GAAP the agreement entered into in respect of the acquisition
      of Diners shares is being treated for accounting purposes as a commitment
      and it is only subject to disclosure.
                  Pursuant
      to IFRS, such contract represents a derivative that is measured at fair
      value. The fair value as of the date of the transaction will be carried
      against deferred revenue. Changes in fair value are carried to financial
      income or expenses.
 
 9)
              Embedded
      derivatives:
 
 The
      Company has operating lease agreements denominated in foreign currencies,
      which are not the functional currency of any of the parties to the lease
      agreement and are not considered commonly used currencies in contracts of
      sell non financial items in the economic
  environment.
 
 According
      to Israeli GAAP, such lease agreements are accounted for as one unit and
      not separated into components. The periodic lease fees (including the
      relevant exchange rate differences) are recorded in the statement of
      operation as incurred.
 
 Upon
      the transition to IFRS and based on IAS 39, "Financial Instruments -
      Recognition and Measurement", the embedded derivatives in the host lease
      agreements need to be separated and measured at fair value at each balance
      sheet date. Changes in the fair value of the embedded derivatives are
      recognized in each period in the income
  statement.
 
 10)
              Dividend
      declared subsequent to balance sheet
date:
 
 According
to Israeli GAAP, dividends declared subsequent to balance sheet date and before
the date the financial statements were approved were presented in shareholders'
equity as a reduction of retained earnings and an increase in "dividends
declared subsequent to balance sheet date".
  F-91
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 Upon the
transition to IFRS, the Company only provides disclosure of the dividend
declared subsequent to the balance sheet date.
 
 11)
              Other
      expenses and income:
 
 Under
Israeli GAAP, other income and expenses are presented net in the income
statements after “operating income".
 
 Under
IFRS, other income and expenses are presented in the income statements as part
of “operating income” in accordance with IAS 1 - "Presentation of Financial
Statements". The other expenses includes, among other, provisions for
termination benefits and impairment of none financial assets.
 
 12)
              Classification
      of income taxes receivables and income tax
  payable:
 
 Under
Israeli GAAP, income taxes receivable or payable are included among “other
accounts receivable” or "other accounts payable", respectively.
 Pursuant
to the provisions of IAS 1 - “Presentation of Financial Statements”, income
taxes receivable and income tax payable are presented separately in the balance
sheet.
 
 13)
              Classification
      of loans in the balance sheet
 
 Under
Israeli GAAP although covenants regarding to loans were not completely met, the
loans are not classified as a short term loans if the agreement between the
Company and the lender was reached after the balance sheet date and before the
date of approval of the financial statements.
 According
to IFRS, if the agreement between the Company and the lender was reached only
after the balance sheet date, the loans should be classified as a short term
loans.
 
 14)
              Warrants
      issued to investors in subsidiary:
 
 According
to Israeli GAAP, based on the provisions of Accounting Standard No. 22 of
the Israeli ASB, warrants whose exercise price is linked to the Israeli CPI,
were presented as shareholders' equity.
 
 According
to IAS 32, "Financial Instruments - Presentation", such warrants are a financial
liability since their exercise price is not fixed and are therefore presented as
liability under Derivative instruments. The liabilities are measured in
accordance with IAS 39, "Financial Instruments - Recognition and
Measurement". Accordingly, the warrants are presented at fair value at each
balance sheet date and the changes in fair value were recorded as financial
income or expenses.
 
 15)
              Cash
      flows
 
 a.
              Under
      Israeli GAAP, cash flows arising from payments of interest and/or from
      receipt of interest were presented as part of the company's current
      operations.
 
 In
      accordance with an option available under IAS 7 – "Statement of Cash
      Flows" (hereafter – IAS 7), cash flows arising from payments of interest
      are presented among cash flows from financing activities, and receipt of
      interest is presented among cash flows from investing
      activities.
  F-92
  BLUE
SQUARE – ISRAEL LTD.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 36 – DISCLOSURE REGARDING THE
ADOPTION OF IFRS(continued):
 
 b.
              Under
      Israeli GAAP, proceeds from sale or acquisition of marketable securities
      are presented among cash flows from operating
  activities.
 
 Under
      the provisions of IAS7, the company presented proceeds from sale or
      acquisition of marketable securities classified as financial assets at
      fair value through profit or loss among cash flows from operating
      activities.
  F-93
  APPENDIX
 BLUE
SQUARE – ISRAEL LTD.
  DETAILS
OF PRINCIPAL SUBSIDIARIES, PROPORTIONATELY CONSOLIDATED COMPANIES
  AND
ASSOCIATED COMPANIES
  AT
DECEMBER 31, 2008
  Holding Company
              
              Name of Company
              
              Percentage of
                  ownership and control
                  by holding Company as
                  of December 31,
                  2008Blue
      Square-Israel Ltd.
              
              The
      Blue Square ChainInvestments
      & Properties Ltd.
              
              100%
              
              SubsidiaryBlue
      Square Real Estate Ltd.
              
              80%
              
              SubsidiaryBee
      Group Ltd.
              
              85%
      (see note 5a1c)
              
              Subsidiary
                (see
      note 5a1c)Eden
      Briut Teva Market Ltd.
              
              51%
              
              SubsidiaryDiners
      Club Israel Ltd.
              
              36.75%
              
              See
      note 32(1)Loyalty
      plan-partnership
              
              75%
              
              See
      note 32(1)The
      Blue Square Chain Investments & Properties Ltd.
              
              Blue
      Square Chain (Hyper Hyper) Ltd.
              
              100%
              
              SubsidiaryCenter
      Investments 1108 Ltd.
              
              50%
              
              Proportionately
      consolidatedIzdarehet
      Investments Company Ltd.
              
              50%
              
              Proportionately
      consolidatedThe
      Blue Square Chain (Hyper Hyper)  Ltd.
              
              Hyper
      Lod Center Ltd.
              
              100%
              
              SubsidiaryShefa
      Mehadrin Ltd.
              
              100%
              
              SubsidiaryRadio
      Non-Stop Ltd.
              
              33%
              
              Associated
      CompanyBlue
      Square Real Estate Ltd.
              
              Kenyon
      Hadar Management Company Ltd.
              
              50%
              
              Proportionately
                consolidatedJoint
      venture Blue Square - Hadar
              
              50%
              
              Proportionately
                consolidatedLogistic
      Center Bee Square Real Estate Ltd.
              
              50%
              
              SubsidiaryBee
      Group Ltd.
              
              Na'aman
      Porcelain Ltd
              
              60.4%
              
              SubsidiaryNa'aman
      Porcelain Ltd.
              
              Sheshet
      Chain of Stores for Household Utensils Ltd.
              
              100%
              
              SubsidiaryVardinon
      Textile Ltd.
              
              85%
              
              SubsidiaryLogistic
      Center Bee Square Real Estate Ltd.
              
              50%
              
              Subsidiary
 
 —————————————
   F-94






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.
  BLUE
      SQUARE-ISRAEL LTD.By:
                    
                    /s/ Zeev VurembrandName:
                    Zeev
      VurembrandTitle:
                    President
      and Chief ExecutiveOfficerBy:
                    
                    /s/ Dror MoranName:
                    Dror
      MoranTitle:
                    Vice
      President and Chief FinancialOfficer
 
 Date: 
June 28, 2009