---

---

# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2005
|- | --------------------------------------------------------------------------------------------------------------------------------

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) 

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

|                                                 |                                          
|------------------------------------------------ | -----------------------------------------
|
|
|
|
|Title of class                                   | Name of each exchange on which registered
|American Depositary Shares, each                 | New York Stock Exchange, Inc.            
|representing one Ordinary Share (1)             
|                                                 |                                          
|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:

38,950,091 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 o No x

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

Yes o   No  x

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

x Yes    o 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  o Non-accelerated filer  x

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

x Item 17    o Item 18



---

---





# 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 and
(c) BSIP means Blue Square Chain Investments & Properties Ltd., a
corporation of which we held 80.7% of the outstanding shares as of March 31, 2006, and the
balance of whose shares are publicly held and traded on the Tel Aviv Stock Exchange.

We
are a leading food retailer in the State of Israel. Through our supermarkets, we offer a
wide range of food and beverages products and also Non-Food items, such as
housewares, 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 and prescription drugs (called
Near-Food in this annual report). As part of our strategy, in 2005, we
continued to expand the range of Non-Food and Near-Food products
and to offer a wider selection of these products to consumers in our stores. As of the
date of this Annual Report, we have established All for a Dollar, toy and
housewares sections within most of our large stores. As of December 31, 2005, we owned and
operated 168 supermarkets under the brand names Mega, Super Center and Shefa Shuk. In
addition, recently we transferred all of our directly-owned real estate assets and certain
liabilities to a new wholly owned real estate subsidiary. For further information
regarding our real estate, see Item 4. Information on The Company  B. Business
Overview  Real Estate. 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  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, 2005, which was NIS 4.603
per $1.00, except figures for the first quarter of 2006, which are based on the
representative exchange rate between the NIS and the dollar as published by the Bank of
Israel for March 31, 2006, which was NIS 4.665 per $1.00.

Our
consolidated financial statements appearing in this annual report are prepared in NIS, in
accordance with generally accepted accounting principles in Israel, referred to in this
annual report as Israeli GAAP.

# NOTE REGARDING
TRANSITION TO NOMINAL-HISTORICAL 
FINANCIAL REPORTING

|With
effect from January 1, 2004, the Company has adopted the provisions of Israel Accouting
Standard No. 12, Discontinuance of Adjusting Financial Statements for
Inflation, of the Israel Accounting Standard Board and, pursuant thereto, the
Company has discontinued, from such date, the adjustment of its financial statements for
the effects of inflation in Israel.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The
amounts adjusted for the effects of inflation in Israel, presented in the financial
statements as of December 31, 2003 (the transition date), were used as the
opening balances for the nominal financial reporting in the following periods.
Accordingly, the amounts reported in these financial statements that relate to
non-monetary assets (including the depreciation and amortization thereon), investments in
associated company and equity items, which originate from the period that preceded the
transition date, are based on the adjusted-for-inflation data (based on the CPI for
December 2003), as previously reported.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|All
the amounts originating from the period after the transition date are included in the
financial statements based on their nominal values. Through December 31, 2003, the Company
prepared its financial statements on the basis of historical cost adjusted for the changes
in the general purchasing power of the NIS, based upon changes in the consumer price index
(the CPI), in accordance with pronouncements of the Institute of Certified
Public Accountants in Israel.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Components
of the income statements for 2003 were, for the most part, adjusted as follows: the
components relating to transactions carried out during the reported period  such as
sales, purchases and labor costs  were adjusted on the basis of the index for the
month in which the transaction was carried out, while those relating to nonmonetary
balance sheet items (mainly changes in inventories and depreciation and amortization) were
adjusted on the same basis as the related balance sheet item. The financing component
represents financial income and expenses in real terms and the erosion of balances of
monetary items during the year.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



---

---



# TABLE OF CONTENTS

|          |                                                                              | Page
|--------- | ---------------------------------------------------------------------------- | ----
|
|
|
|
|PART I    |                                                                              | 1   
|ITEM 1.   | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                        | 1   
|ITEM 2.   | OFFER STATISTICS AND EXPECTED TIMETABLE                                      | 1   
|ITEM 3.   | KEY INFORMATION                                                              | 1   
|ITEM 4.   | INFORMATION ON THE COMPANY                                                   | 15  
|ITEM 4A.  | UNRESOLVED STAFF COMMENTS                                                    | 36  
|ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 | 36  
|ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   | 59  
|ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            | 80  
|ITEM 8.   | FINANCIAL INFORMATION                                                        | 88  
|ITEM 9.   | THE OFFER AND LISTING                                                        | 91  
|ITEM 10.  | ADDITIONAL INFORMATION                                                       | 94  
|ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 109 
|ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 111 
|         
|PART II   |                                                                              | 112 
|         
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 112 
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 112 
|ITEM 15.  | CONTROLS AND PROCEDURES                                                      | 112 
|ITEM 16.  | [RESERVED]                                                                   | 112 
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                             | 112 
|ITEM 16B. | CODE OF ETHICS                                                               | 113 
|ITEM 16C. | ACCOUNTANTS FEES AND SERVICES                                                | 113 
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                   | 114 
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       | 114 
|         
|PART III  |                                                                              | 115 
|         
|ITEM 17.  | FINANCIAL STATEMENTS                                                         | 115 
|ITEM 18.  | FINANCIAL STATEMENTS                                                         | 115 
|ITEM 19.  | EXHIBITS                                                                     | 115 

i

---

---



# 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, 2004
and 2005 and for each of the years ended December 31, 2003, 2004 and 2005 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, 2001, 2002, and
2003 and for each of the years ended December 31, 2001 and 2002 from our audited
consolidated financial statements not included in this annual report. We prepare our
consolidated financial statements in conformity with Israeli GAAP. As described in note 18
to our consolidated financial statements included elsewhere in this annual report, Israeli
GAAP differs in certain respects from U.S. GAAP. See Item 5. Operating and Financial
Review and Prospects  Critical Accounting Policies. You should read the
selected consolidated financial data together with the section of this annual report
entitled Item 5. Operating and Financial Review and Prospects and our
consolidated financial statements included elsewhere in this annual report.

1

---

---



|                                            | 2001 | 2002 | 2003 | 2004      | 2005 | 2005
|------------------------------------------- | ---- | ---- | ---- | --------- | ---- | ----
|
|
|
|
|Income Data                                 |      |      |      |           |      |     
|                                            |      |     
|Sales                                       |      |      |      | 5,828,391 |      |     
|                                            |      |     
|Cost of sales                               |      |      |      | 4,215,439 |      |     
|                                            |      |     
|Gross profit                                |      |      |      | 1,612,952 |      |     
|Selling, general and administrative         |      |     
|expenses                                    |      |      |      | 1,296,217 |      |     
|                                            |      |     
|Operating income                            |      |      |      | 316,735   |      |     
|                                            |      |     
|Financial income (expenses), net            |      |      |      | (13,109   | )    |     
|                                            |      |     
|Amortization of goodwill                    |      |      |      | (5,277    | )    |     
|                                            |      |     
|Other income (expenses), net                |      |      |      | (18,152   | )    |     
|                                            |      |     
|Taxes on income                             |      |      |      | 107,823   |      |     
|                                            |      |     
|Equity in net earnings (loss) of affiliates |      |      |      | 3,561     |      |     
|                                            |      |     
|Minority interest                           |      |      |      | 25,123    |      |     
|                                            |      |     
|Net income (loss)                           |      |      |      | 150,812   |      |     
|Earnings (loss) per ordinary share          |      |     
|or ADS from continuing Operations           |      |      |      | 3.93      |      |     
|Total Earnings (loss) per ordinary          |      |     
|share or ADS                                |      |      |      | 3.93      |      |     
|Cash dividends per ordinary share           |      |     
|or ADS                                      |      |      |      | 1.35      |      |     
|U.S. GAAP:                                  |      |     
|                                            |      |     
|Net income (loss)                           |      |      |      | 151,393   |      |     
|                                            |      |     
|Earnings (loss) per ordinary share          |      |     
|or ADS from continuing operation            |      |      |      | 3.94      |      |     
|Total Earnings (loss) per ordinary          |      |     
|share or ADS                                |      |      |      | 3.94      |      |     
|Selected Operating Data:                    |      |     
|                                            |      |     
|Number of stores (at year end)              |      |      |      | 171       |      |     
|                                            |      |     
|Increase (decrease) in same store           |      |     
|sales (3)                                   |      |      |      | (7.3      | )%   |     
|Total square meters (at year end)           |      |      |      | 279,000   |      |     
|                                            |      |     
|Sales per square meter (in NIS) (4)         |      |      |      | 22,017    |      |     
|                                            |      |     
|Sales per employee (in thousands) (5)       |      |      |      | 716       |      |     

---

|(1) | For
the years 2001-2003, these amounts have been adjusted to reflect changes in the Israeli
  consumer price index as of December 31, 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(2) | 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,  2005 (NIS 4.603
=$1.00), as published by   the Bank of Israel.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | For
more  meaningful  comparison,  the Company has changed the policy by which it calculates
Same   Store  Sales.  As of the date of this  annual  report and  hereafter,  the
 Company's  Same Store  Sales   calculation is currently  based only on stores:  (1) that
operated  continuously  throughout the current   and prior  reporting  period  (i.e.,
 stores that were open on January 1, 2004 and were not  permanently   closed  during
 2004 or 2005);  and (2) that have not been  resized  significantly  during  the  period.
  Previously,  the Company's Same Store Sales referred to the sales of those stores
operated  continuously   during the entire  reporting  period or the  preceding  period.
 Stores were not deemed to have operated   continuously  (and  therefore not included as
"Same Stores") if such stores were closed for at least two   weeks  during the  reported
 period or the  preceding  period for any reason,  including  renovation  or
  relocation.  The Same Store Sales  information in this table for the years 2001 through
2005 is based on   this new policy.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

2

---

---



|(4) | Based
on an average total square meters at month end during the relevant year.
|--- | ------------------------------------------------------------------------------

|(5) | 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
with the Sales Per Employee for the previous  periods,   the number of employees used to
calculate Sales Per Employee for all previous  periods has been adjusted   to excluding
cleaning personal.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | December 31, | 
|------------------------ | ------------ | 
|
|
|
|
|Balance Sheet Data:      |              | 
|Israeli GAAP:            |              | 
|Working capital deficit. |              | 
|Total assets             |              | 
|Short-term credit from   |              | 
|banks and others         |              | 
|Long-term debt           |              | 
|Shareholders' equity     |              | 
|U.S. GAAP:               |              | 
|Total assets             |              | 
|Shareholders' equity     |              | 

|(1) | For
the years 2001-2003, these amounts have been adjusted to reflect changes in
               the Israeli consumer price index as of December 31, 2003.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | 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, 2005 (NIS 4.603 = $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, we could experience a material adverse effect on our business, operating results
and financial condition and the share and ADS price of Blue Square may decline. We cannot
assure you that we will successfully address any of these risks.

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

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,
Super Sol, low-priced private supermarkets, 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.

3

---

---



In
recent years, due to a recession and an increase in unemployment in Israel, the most
important factor in the purchase decisions of a larger portion of the Israeli public has
been the price of the products it purchases. Even following the improved economic
environment in 2004 and 2005, price has remained a significant factor in the purchase
decisions of many consumers. As a result, we and other major chains have continued our
expansion into low-priced store formats and, other supermarket chains have expanded into
hard discount formats. In addition, in response to the increased focus on the price of
products, private supermarkets have continued to expand their presence in selected areas,
increasing competition in an already difficult market, although the growth in market share
of such private supermarkets slowed during 2005. These private supermarkets 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. Due to the above developments, we
closed a number of underperforming stores during 2005. Large supermarket chains in Israel,
including us, are kosher and therefore do not offer non-kosher food or operate on
Saturdays.

In
2005, a number of small private supermarkets 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. Such a combination may generate
efficiencies of a major national-spread chain and enable them to compete more efficiently
with us.

During
2005, the other two major chains, Super Sol and ClubMarket, merged following the
bankruptcy proceedings of ClubMarket. As a result of such merger, we now face a major
competitor, many of whose stores are characterized by the every day sale of products at
low prices. As opposed to previous years during which our market share was close to that
of Super Sol, we estimate that Super Sols market share following the acquisition of
ClubMarket was approximately 39.5% of the bar-coded market in Israel in 2005, as opposed
to our own approximately 24.7% share of the bar-coded market during 2005. This increased
difference in market share may give Super Sol 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.

4

---

---



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, 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. 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.

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.

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 Cooperative,
or Tnuva, an Israeli food cooperative, which holds a leading position in the domestic
dairy and poultry markets. In 2005, Tnuvas products accounted for approximately
12.4% of all the products sold at our supermarkets. In addition, Strauss-Elite group, an
Israeli food manufacturer, accounted in 2005 for approximately 9.8% of all products sold
at our supermarkets, and the Osem group accounted for approximately 7.1% of all products
sold at our supermarkets in 2005. 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-Elite 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-Elite
group or Osem obligating them to supply products to us. The ten largest suppliers
accounted for approximately 47.5% of our products purchases in 2005. 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. Further, we cannot assure you that,
in the future, Tnuva, Strauss-Elite group, Osem or any of these other suppliers will not
significantly raise the prices of the products they supply us, or encounter difficulties
in providing these products to us, in either of which cases our operating results might be
adversely affected.

5

---

---



Bronfman-Alon is able to control
the outcome of matters requiring shareholder approval.

Bronfman-Alon
Ltd. (Bronfman-Alon) currently owns approximately 76.89% of Blue Squares ordinary
shares following the conversion by other investors of an aggregate of approximately NIS
19.3 million in principal amount of our 5.9% convertible debentures since their issuance
in August 2003. So long as Bronfman-Alon, 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, 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.

We
directly operate all of the supermarkets that Blue Square owns directly and those that are
owned by BSIPs subsidiaries. As of December 31, 2005, Blue Square owned directly 104
supermarkets; the balance of our operations were owned by BSIPs subsidiaries, each
of which has its own board of directors and management. These subsidiaries include BSIP,
in which Blue Square owns an 80.7% interest, and the Blue Square Chain (Hyper Hyper) Ltd.,
or Hyper Hyper, in which BSIP owns a 100% interest and, therefore, Blue Square indirectly
owns an 80.7% interest. The ordinary shares of BSIP that are not owned by Blue Square are
publicly held and traded on the Tel Aviv Stock Exchange. The consolidated sales of BSIP
and its subsidiaries in 2005 aggregated approximately NIS 3,760 million, or $817 million,
representing approximately 65% of our consolidated sales for 2005. At December 31, 2005,
the total consolidated assets of BSIP and its subsidiaries aggregated approximately NIS
1.2 billion, or $266 million, constituting approximately 33.2% of our total consolidated
assets at December 31, 2005.

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 these
subsidiaries at arms-length. Some transactions between Blue Square and a
subsidiary, including any investment by Blue Square in a subsidiary, 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.

6

---

---



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. Furthermore, 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.

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, minimum wage equals 47.5% of the average wage for an
employee in Israel. The minimum monthly wage since April 2006 has been NIS 3,456.58, or
approximately $751. However, the new Israeli government, pursuant to the coalition
guidelines adopted this year, announced a goal of increasing the minimum monthly wage to
NIS 4,600 or $1,000, to be reached in two stages. In the first stage, pursuant to recently
adopted legislation, the minimum wage is to be increased (i) effective as of June 1, 2006,
to NIS 3,585, (ii) effective as of April 1, 2007, to the higher of NIS 3,710 or 47.5% of
the average wage as of April 1, 2007, and (iii) by June 1, 2007, to NIS 3,835. The further
increases are to be determined by a special committee which is to submit its
recommendations by July 1, 2007. An increase in minimum wage will increase our labor costs
and thus adversely affect our operating results.

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;
|- | -------------------------------------

7

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| | 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.

Restrictions on the payment of
dividends may limit 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 financial obligations (as defined by Maalot, an Israeli rating agency, and
affiliate of S&P) (Maalot) to EBITDA for any quarter exceeds 3.5 until June 30, 2006
or exceeds 3.0 thereafter. Blue Squares Board also resolved that Blue Square would
not distribute dividends in any quarter if the ratio of the cost of unencumbered fixed
assets as set forth on our financial statements (following depreciation) to financial
obligations (as defined by Maalot) for any quarter is below 120%. Maalot has informed us
that a change in this Board resolution may lead to a downgrading of the rating on our 5.9%
unsecured debentures. Following the dividends distributions of 2003 through 2006 to date,
the retain earnings of Blue Square decreased significantly. As a result of this Board
resolution and the other restrictions, we may not be able to pay cash dividends on our
ordinary shares in the same amount as in the past, and you may not be able to receive
adequate return on your shares through the payment of dividends.

8

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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 are currently convertible into Blue Square ordinary shares at per share price
of NIS 30.836. 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, 2006, the closing
price per share of our ordinary shares on the Tel Aviv Stock Exchange was NIS 51.40.

Our
issuance of ordinary shares to holders of our convertible debentures, 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
May 29, 2003, the Commissioner of the Israeli Antitrust Authority announced that it had
concluded its investigation into alleged restrictive trade arrangement between major
supermarket chains in Israel and large suppliers. The Commissioner publicized a document
of direction, which contained his view of the legality of certain commercial conduct
between the large supermarket chains (which consisted of Super Sol, ClubMarket and us) and
the large suppliers, which was exposed during the investigation.

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. The Commissioner announced the following operational measures to enforce the law:

| |  | The
legal department of the Israeli Antitrust Authority is to take appropriate legal
proceedings against any party to a clear violation of the law exposed during the
investigation and, if necessary, take prospective legal measures, such as injunctions and
issuing directives to monopolists.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Demand
from the relevant supermarket retail chains and food suppliers to provide all existing
agreements and arrangements with regard to year 2004 in order to ensure that the illegal
practices have ceased and that the recommendations of the Commissioner have been
implemented.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9

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| |  | To
review the practices and customs between the dominant suppliers and other supermarkets
(i.e., which are not among the major supermarket retail chains) in order to confirm the
legality of these arrangements under the antitrust laws.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 adopted by us.

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. We and the other major chains held a few meetings with the Commissioner with
respect to his final position document described above and the contents of the proposed
consent decree; however, we did not reach an understanding with the Commissioner and our
negotiations have ceased. 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.

During
December 2005, the Commissioner issued a draft of consent decree directed at specific food
suppliers, which was later submitted to the Restrictive Trade Practices Court for
approval. The draft consent decree stipulates various prohibitions, conditions and
restrictions that would apply to certain practices of these suppliers. The draft 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
proposed consent decree; however, it could nevertheless have an effect on the practices of
the Companys suppliers.

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.

10

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The proposed amendment to the Law
for Deposits on Beverage Containers, 1999, would impose significant expenses and costs on
us, which could have a material adverse effect on our results of operations.

The
Knesset, the Israeli parliament, is considering amending the Law for Deposits on Beverage
Containers, 1999, which would require us to charge a deposit for drink containers of more
than 1.5 liters and accept the return of empty containers for refund. This would also
require us to store the containers until collected by the manufacturers and/or importers.
The current law only applies to containers of less than 1.5 litres. This proposed
amendment to the law would impose on us significant expenses and costs, which could have
an adverse effect on our results of operations. For more information on this proposed
amendment, please see Item 4. Information on The Company  B. Business Overview
 Government Regulation.

Impact of inflation and currency
fluctuations might affect our sales and our operating results. Increases in oil, raw
material and product prices in recent years may affect our operating results.

Inflation
in Israel increases our expenses, which because of competitive pressures are generally not
offset, fully or as quickly, by increases in our selling prices and revenues. In addition,
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 and affecting our sales and operating results.

In
addition, the sharp increase in oil prices in recent years has led to increase of our
electricity prices and raw materials used in the plastic packing industry. Further
increase in oil prices would impose on us significant expenses and costs, which could have
an adverse effect on our operation results.

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

We
have one 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 generated approximately 23% of our total percentage sales during 2005.
Our inability to utilize the distribution center 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 to institutions, companies
and individuals, particularly during the High Holiday and Passover seasons. The gift
certificates can be used in our stores as well as other stores with which we entered into
collaboration agreements. In 2006, we started marketing prepaid electronic cards. We are
exposed to risks connected with the issuance of such certificates, including risks that
they may be fraudulently forged or stolen. A substantial or large scale forgery or theft
may cause a reduction in our revenue and increases our expenses.

11

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# 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 Dor Alon group and with the Africa Israel group (an
interested party in Dor 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 Bronfman-Alon Ltd. and other corporations
under control of the Dor Alon group and the Africa Israel group. Blue Square and its
subsidiaries may face limitations from time to time in their ability to obtain additional
credit from Israeli banks due to these Bank of Israel regulations, which would adversely
affect our ability to operate our business as we have in the past. In addition, in
February 2006, a group of investors, which included one of our related parties, completed
an acquisition of the controlling interest inIsrael Discount Bank
Ltd. Following such acquisition, the Company is deemed a related party of Discount Bank,
and therefore our relationship with Discount Bank is subject to certain restrictions under
the regulations of the Bank of Israel.

# Use of technological
information systems

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.

The transition to nominal
financial reporting could have an adverse effect on our results of operations

In
accordance with Israeli Accounting Standard No. 12 adopted by the Israeli Accounting
Standards Board, our financial statements ceased to be adjusted for inflation in Israel
for periods beginning on or after January 1, 2004. The amounts included in our financial
statements as of December 31, 2003 served as the starting point for nominal financial
reporting beginning January 1, 2004. The adoption of Standard No. 12 could have material
adverse effect on our results of operations. As a result of the adoption of this standard,
our assets and shareholders equity ceased to be adjusted for inflation in Israel, while
the repayment of interest and principal under most of our loans and all debentures
continues to be linked to the Israeli CPI, as provided in our loan and debenture
agreements. 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.

12

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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, hostilities between Israel and the Palestinian Authority have
substantially increased. These hostilities include terrorist acts in Israel and military
operations in the West Bank and Gaza. In January 2006, Hamas, an Islamic movement
responsible for many attacks against Israelis, won the majority of the seats in the
Parliament of the Palestinian Authority. The election of a majority of Hamas-supported
candidates is expected to be a major obstacle to relations between Israel and the
Palestinian Authority, as well as to the stability in the Middle East as a whole.

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.

Hostilities between Israel and the
Palestinians have adversely affected our operating results.

The
hostilities between Israel and the Palestinians referred to above have and may affect our
business in a number of ways. First, we have incurred additional costs to maintain the
security of our customers. As a condition of the receipt of permits of municipal
authorities, depending on the size of the store, we are required to hire security
personnel and security equipment for each store. In addition, the police may impose new
security demands, based on the location and size of each store. Second, security concerns
may decrease traffic in our stores, especially in stores located in malls. The occurrence
of violence at any of our stores or at any of the stores of our competitors may discourage
our customers from visiting our supermarkets. It is difficult to predict when the
hostilities between Israel and the Palestinians will terminate and to what extent the
hostilities will affect our operating results.

13

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# Economic conditions in
Israel affect our financial performance.

All
of our sales are made in Israel and a substantial majority of the goods that we sell are
grown, manufactured or processed in Israel. Consequently, our financial performance is
dependent to a significant extent on the economy of Israel. During 2002, Israels
Gross Domestic Product declined by 1.2%, while in 2003, 2004 and 2005, it rose by 1.7%,
4.4% and 5.2%, respectively. The economic slowdown during 2002 and a portion of 2003
adversely affected our financial performance. Initial reports indicate that the Israeli
economy grew by 6.6% at the first quarter of 2006. We cannot be sure how any growth or
decline in the Israeli economy will affect our financial performance.

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, some of the products we offer in our stores,
including bread, flour, eggs, milk and margarine are subject to government-imposed price
controls. Recently, a new requirement has been imposed requiring bread suppliers to sell
certain basic bread to retailers, such as the Company, at certain fixed prices
(from May 2006 for an initial period of six months). 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.

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. Most of 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.

14

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|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.

Effective
January 1, 1996, we and our former controlling shareholder, the Co-Op, completed a
reorganization of holdings, pursuant to which the Co-Op transferred to Blue Square in
consideration for 29,789,000 of Blue Squares ordinary shares, its then 67% interest
in BSIP and other shareholdings and rights. 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.

In
June 2003, Bronfman  Alon acquired 78.1% of the outstanding shares of Blue Square
from the Co-Op. See - Change in Control below. Bronfman-Alon currently owns
approximately 76.89% of the outstanding shares following to the conversion by other
investors of an aggregate of approximately NIS 19.3 million in principal amount of our
5.9% convertible debentures since their issuance in August 2003.

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

| | The
issuance in 2003 of NIS 400 million in aggregate principal amount of unsecured 5.9%
debentures (with final maturity dates of either 2011 or 2014), half of which are
convertible into Blue Square ordinary shares. As of June 15, 2006, the per share
conversion price of the convertible debentures was NIS 30.836 and is subject to
adjustment for cash dividends that may be distributed from time to time. The debentures were
rated AA by Maalot (an Israeli rating agency) so long as the limitations on
the distribution of dividends are in accordance with the decisions of the Board of
Directors (see Item 3. Key Information  D. Risk Factors. Restrictions on the
payment of dividends may limit our ability to pay cash dividends on our ordinary shares).
Maalot confirmed the AA rating on the debentures in June 2006;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
payment of dividends from June 2003 to June 2006 totaling approximately NIS 719.3 million
($159 million) (see Item 3. Key Information  D. Risk Factors. Restrictions on
the payment of dividends may limit our ability to pay cash dividends on our ordinary
shares);
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
implementation of an efficiency plan, including the dismissal of employees, replacement
of maintenance and security contractors via new tenders, outsourcing some of our
activities, and closing underperforming stores (stores with negative cash flow);
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15

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| | The
consolidation of our store formats into just three in order to focus our marketing
efforts more effectively and differentiate our store brands, and the operation of our
three store formats as autonomous divisions in order to incorporate marketing and
operations decision-making at the level of our three store divisions to improve the
performance of our individual store formats;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
increase of the variety of Non-Food and Near-Food items, which
have higher average margins, with the goal of increasing the portion of our customers overall
shopping needs that are addressed in our stores. As part of this strategy, in 2005, we
acquired 50% of the holdings of Hamachsan Hamerkazi Kfar Hashaashuim Ltd.
(Central Warehouse/Toy Village)", Israels largest franchiser of All for
a Dollar, toy and houseware stores. In addition, we sell over the counter
pharmaceutical medical products (OTC drugs) to further expand the mix of
goods sold in our stores;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
establishment of a new joint loyalty plan with Dor Alon Energy In Israel (1988) Ltd. and
the agreement to acquire, together with Dor Alon, 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 closing of this acquisition is subject to the satisfaction of certain
conditions; and
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
transfer of our real estate assets (excluding real estate owned by BSIP and its
subsidiaries) and certain liabilities (including lease agreements with third parties and
with BSIP) to a new wholly owned subsidiary that will manage approximately 146,000 square
meters currently occupied by Blue Squares stores and other lessees, as well as the
unoccupied land and unused building rights previously under Blue Squares ownership, in an
effort to maximize their value (see Item 4. Information on The Company  B.
Business Overview  Real Estate.).
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 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, 2006, we invested NIS 8.7 million, or $1.9
million, in fixed and other assets. In 2005, we invested NIS 89.1 million, or $19.3
million, in fixed and other assets, a 0.4% decrease from our 2004 investment of NIS 89.4
million. Of our fixed asset investment in 2005, we invested NIS 2.2 million, or $0.5
million, in land and buildings, including land that we lease, as compared with NIS 13.3
million in 2004. In 2003, we invested NIS 138.7 million in fixed and other assets. As of
December 31, 2005, we had entered into agreements for investments in fixtures and
equipment in an aggregate of NIS 8 million, or $1.7 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.

16

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Change
in Control

On
April 10, 2003, the District Court of Tel Aviv declared Bronfman-Alon as the winning bid
of the tender for the sale of the holdings of Co-Op in Blue Square, in a court-supervised
sale of the Co-Ops 78.1% interest in Blue Square. In June 2003, Bronfman-Alon
acquired the shares for the amount of NIS 1,337 million (the equivalent of $288.3 million
on the date of the submission of the bid) plus interest to the date of purchase.

During
2005, the Dor-Alon group, which owned a 50% interest in Bronfman-Alon,
acquired shares in Bronfman-Alon held by the Bronfman-Fisher group, which also
owned a 50% interest in Bronfman-Alon. Following such acquisition, the Dor-Alon group
owned 73.5% of Bronfman-Alon, and the Bronfman-Fisher group owned 26.5% of Bronfman-Alon.

For
a  description  of the  ownership in  Bronfman-Alon,  please see "Item 7. Major
 Shareholders and Related Party Transactions - A. Major Shareholders".

| | B. | Business
Overview.
| | -- | ------------------

# General

We
are a leading food retailer in the State of Israel. Through our supermarkets, we offer a
wide range of food and beverages products and also Non-Food items, such as
housewares, toys, 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 and prescription drugs, and
recently started to operate several All for a Dollar, toy and housewares
departments within most of our large stores. As of December 31, 2005, we owned and
operated 168 supermarkets under the brand names Mega, Super Center and Shefa Shuk. Our
activities are carried out via Blue Square and its consolidated subsidiaries, the largest
of which is BSIP. As of March 31, 2006, Blue Square owned 80.7% of the outstanding shares
of BSIP, the balance of which were publicly held and traded on the Tel Aviv Stock
Exchange. BSIP and its direct and indirect subsidiaries, including Blue Square Chain
(Hyper Hyper) Ltd., are the owners of 64 of our supermarkets. The consolidated sales of
BSIP and its subsidiaries in 2005 aggregated approximately 65% of our consolidated sales
for that period. As of March 31, 2006, the total consolidated assets of BSIP and its
subsidiaries aggregated approximately NIS 1.3 billion, or $278 million, constituting
approximately 33.0% of our total consolidated assets at that date.

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

17

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|                        | No. of Stores | Store Space
(square meters)
|----------------------- | ------------- | ---------------------------
|
|
|
|
|As of December 31, 2001 |               |                            
|As of December 31, 2002 |               |                            
|As of December 31, 2003 |               |                            
|As of December 31, 2004 |               |                            
|As of December 31, 2005 |               |                            

We
have three store formats  Mega, Super Center and Shefa Shuk. In the Mega
chain stores, which are located primarily outside the city centers, we offer the widest
selection of food, Near-Food and Non-Food items at reduced prices.
In the Super Center chain stores, which are usually smaller than
Mega stores and are located primarily in local neighborhoods and city centers,
we offer a more limited selection of food, Near-Food and Non-Food
items at competitive prices. Our Shefa Shuk chain stores are low priced stores
with a selection of products specially oriented towards Israels growing
ultra-orthodox population and also designated to compete with local competition. As of
December 31, 2005, we operated 40 Mega Stores, consisting of approximately 164,000 square
meters space, 93 Super Center stores, consisting of approximately 94,000 square meters
space, and 35 Shefa Shuk stores, consisting of approximately 54,000 square meters space.

We
operate a Buy & Bonus frequent-buyer incentive program and a
Mega frequent-buyer incentive program, which are designated to increase
consumer traffic and encourage customers to patronize our stores and to allow our
customers to earn free gifts by earning points. These customer clubs grant a variety of
discounts and benefits to participants. The benefits are published each month in a
Buy & Bonus magazine which is distributed in our stores and in the general
media. On November 29, 2005, we established a new loyalty plan with Dor Alon Energy In
Israel (1988) Ltd. and entered into an agreement to acquire, together with Dor Alon, 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 closing of this acquisition is
subject to the satisfaction of certain conditions. See Item 4. Information on The
Company  B. Business Overview  Marketing.

# Industry Overview

We
estimate that retail sales of food, beverages and tobacco in Israel was approximately NIS
44 billion, or $9.4 billion, in 2005. 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 2004 (2005 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
2005 (4.6%).

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: Super Sol (including
ClubMarket) and us, as well as other smaller but developing chains.

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We
estimate that significant growth opportunities for supermarkets in Israel remain as more
households increase purchasing of supermarket goods at supermarkets rather than smaller
grocery stores, mini-markets and open-air markets. We estimate that approximately 34% of
the total retail sales of food, beverages and tobacco in Israel in 2005 was made by the
three large chains and 46% was made by all 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.

# Our Supermarkets

We
operate three supermarket formats, tailoring store sizes and product ranges to meet the
preferences of each formats target customers. Our supermarket formats are among the
most recognized in Israel. According to A.C. Nielsen, our market share of the bar-coded
market of non-durable goods in 2005 was 24.7%.

See
Our Operations for a description of our supermarket formats as of December 31,
2005.

# 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, 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 report in
either the third or the fourth quarter. 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 is to take advantage of our position as a leading food retailer in Israel, by
expanding our market presence in existing retail food markets. To achieve this goal, we
intend to pursue a number of operating and growth strategies, which include:

| | increasing our market share by opening additional store locations, improving and enlarging
existing stores and, if necessary, reducing and/or closing underperforming stores;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | increasing
our market share of Non-Food and Near-Food products and to offer
a wider selection of these products to consumers in our stores, including small
electrical appliances, computers and computer accessories, textile and leisure products
(such as videos and magazines). As part of this strategy, in February 2005 we acquired
50% of the holdings of Hamachsan Hamerkazi Kfar Hashaashuim Ltd. (Central
Warehouse/Toy Village)", Israels largest franchiser of All for a Dollar,
toy and houseware stores;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | considering
the possibility of offering and selling other products, such as financial instruments,
personal finance and insurance products, to our consumers;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | exploring
various alternatives to maximize the potential value of our real estate assets, including
unused building rights. As part of this strategy, in June 2006, we transferred our real
estate assets (excluding real estate owned by BSIP and its subsidiaries) and certain
liabilities (including lease agreements with third parties and with BSIP) to a new wholly
owned subsidiary (BSRE), and the Board of Directors of BSRE approved the filing of a
draft prospectus for an initial public offering (IPO) on the Tel Aviv Stock Exchange,
although there is no guarantee that such offering will in fact be completed;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | differentiating
our store brands and products from those of our competitors;
|- | ----------------------------------------------------------------------------

| | increasing
operational efficiency;
|- | ----------------------------------

| | focusing
on  improving  the  availability  of products in our stores and reducing the shortage of
         products "on the shelves"; and
|- | -----------------------------------------------------------------------------------------------------------------------------------------

| | establishment
of a new loyalty plan for the benefit of our customers.
|- | ---------------------------------------------------------------------

# Real Estate

Most
of our acquisitions of real estate have been in connection with the retail operation of
our stores. Nevertheless, through our Real Estate Development Division, we are exploring
various alternatives to maximize the potential value of our real estate assets, including
our unused building rights.

Recently,
we transferred our real estate assets (excluding real estate owned by BSIP and its
subsidiaries), all related rights and obligations and certain liabilities (including lease
agreements with third parties and with BSIP) to Blue Square Real Estate Ltd. (BSRE), a new
wholly owned subsidiary, that will manage approximately 146,000 square meters currently
occupied by our stores and other lessees, as well as the unoccupied land and unused
building rights under our ownership. Among the rights transferred are those pursuant to
long term lease agreements, lease agreements (by or to the Company), 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).

On
May 4, 2005, the Israeli Tax Authority approved our application for a ruling stating that
the transfer will receive favorable tax treatment under the provisions of Sections 104A
and 105A(2) to the Income Tax Ordinance, subject to certain conditions that have not yet
been fulfilled.

As
part of the Companys preparations for the transfer to BSRE of the real estate assets
and related financial obligations, in December 2005 the Company incurred a NIS 500 million
loan from a bank.  The
sum of the loan was deposited in a limited deposit to secure the sum of the loan.

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The
Company has transferred the loan to BSRE at the time of the transfer of the real estate
assets to BSRE, while retaining the proceeds of the loan. The proceeds of the loan will
remain on deposit with the bank lender to secure the repayment by BSRE of the transferred
loan until BSRE provides its own substitute collateral acceptable to the bank lender. The
Income Tax Authority agreed to the Companys request to transfer the loan to BSRE
while maintaining the deposit with the Company.

Further,
the Board of Directors of BSRE has approved the filing of a draft prospectus for an
initial public offering (IPO) on the Tel Aviv Stock Exchange. There is no guarantee that
BSRE will in fact complete such an offering.

For
more information about our real estate, please see - D. Property, Plant and
Equipment below.

# Competition

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,
Super Sol (which includes Clubmarket), low-priced private supermarkets, 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.

We
and the other major chain have expanded into low-priced store formats, and other major
chains have expanded into hard discount formats. In addition, private supermarkets have
continued to expand in selected areas, although the growth in market share of such private
supermarkets slowed during 2005. These private supermarkets 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. Due to the above developments, we closed a number
of underperforming stores during 2005. Large supermarket chains in Israel, including us,
are kosher and therefore do not offer non-kosher food or operate on Saturdays.

On
November 29, 2005, the Commissioner of the Israeli Antitrust Authority granted an
exemption from the obligation to receive approval for a restrictive arrangement with
respect to certain arrangements between the Fourth Chain Company Ltd. (the Fourth
Chain) and certain small private supermarkets chains. This exemption was granted
subject to certain conditions and for initial period of two years. The Fourth Chain
combines a number of small private supermarkets 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 exempted 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. According to the Commissioner decision, the
aforesaid arrangement may generate some of the efficiencies of a major national-spread
chain and therefore enable them to compete more efficiently with the major chains.

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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.

In
addition, due to our entrance into the sale of Near-Food and
Non-Food products, we compete against retail chains and stores outside the
food industry, such as Toys R Us, Office Depot, household stores and others.

# Our Operations

Our
supermarket operations are conducted under the Mega, Super Center and Shefa Shuk store
formats, which are among the most well-recognized retail names in Israel. Pursuant to
organizational changes instituted in 2005, we began to operate our three store formats as
autonomous divisions. As a result of these organizational changes, marketing and
operations decision-making were incorporated at the level of our three store divisions.
The goal was to eliminate corporate-level personnel, while at the same time improving the
performance of our individual store formats.

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. Fifteen of our supermarkets also include
drugstores, which sell medications, prescription medicines, cosmetics, perfume and
personal hygiene items. In addition, we offer a range of Non-Food and
Near-Food items and recently started to operate several All for a
Dollar, toy and housewares departments within most of our large stores. In addition,
we sell over the counter pharmaceutical medical products.

A
portion of our stores operations is owned directly by Blue Square, and the other portion
is owned by Blue Squares subsidiary, BSIP and its subsidiaries. The stores which are
owned directly by Blue Square generally are less than 1,500 square meters, and the stores
which are owned by BSIP and its subsidiaries generally are more than 1,500 square meters.

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The
following table provides certain information regarding the Blue Square stores and the BSIP
stores as of December 31, 2005:

|                 | Blue Square Israel | BSIP | Total
|---------------- | ------------------ | ---- | -----
|
|
|
|
|Mega (1)         |                    |      |      
|                 |                    |     
|Super Center (2) |                    |      |      
|                 |                    |     
|Shefa Shuk (3)   |                    |      |      
|                 |                    |      |      
|Total            |                    |      |      

(1) Large stores (average size of 4,500 square meters), primarily located
          outside of city centers, offering a wide selection of food items and other
          departments at reduced prices.

(2)
          Medium and small size stores primarily located in city centers and local
          neighborhoods offering a more limited selection of food and household items at
          competitive prices.

(3)
          Low-priced supermarkets with a selection of products oriented to ultra-orthodox
          Jewish population and also designated to compete with local competition.

# Purchasing and
Distribution

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.

We
purchase products for our supermarkets from more than 1,100 suppliers, including
manufacturers, importers and distributors. Approximately 82.1% of our grocery items and
88.4% of our meat and fish are delivered directly by suppliers to some of our stores. For
certain other items, including 80.4% (in 2005) of fruits and vegetables, we provide
distribution to our supermarkets through our distribution center. For the year ended
December 31, 2005, approximately 23% of our sales were of products distributed from the
distribution center.

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We
actively seek to diversify our suppliers. However, we purchase most of our dairy, fresh
produce and poultry products from Tnuva, an Israeli food cooperative, which holds a
leading position in the domestic dairy and poultry markets. In 2005 Tnuvas products
accounted for approximately 12.4% of all the products sold at our supermarkets. In
addition, Strauss-Elite group, an Israeli food manufacturer, accounted for approximately
9.8% of all products sold at our supermarkets in 2005, and the Osem group accounted for
approximately 7.1% of all products sold at our supermarkets in 2005. 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-Elite 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-Elite 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 47.5% of our product purchases in 2005. We have
not experienced any material problems in obtaining products of the quantity and type
required.

# 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, 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 Mega club, Buy
& Bonus incentive program, price reductions, gifts, coupons or deferred payment terms.
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.

On
November 29, 2005 we entered into the following agreements:

(a)
          an agreement with Dor Alon Energy In Israel (1988) Ltd. (Dor Alon),
          a related party, establishing a joint loyalty plan for the benefit of Blue
          Squares 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;

(b)
          an agreement among Blue Square and Dor Alon, on one hand, and Diners Club
Israel           Ltd. (Diners Israel), on the other hand, pursuant to which
the           Loyalty Plan will offer to its members a credit card issued by Diners
Israel;           and

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(c)
          an agreement under which Blue Square and Dor Alon would purchase 49% of the
          shares of capital stock of Diners Club Israel Ltd. from Credit Cards for Israel
          Ltd. (CAL) for a total consideration of NIS 21.3 million. The
          purchased shares will be allocated 36.75% to Blue Square and 12.25% to Dor
Alon.           The closing of this latter acquisition is subject to the satisfaction of
certain           conditions. The consideration will be funded through a loan to be
granted by CAL           to the Company and Dor Alon; repayment of the loan will be
secured by the           acquired shares.

The
Loyalty Plans goal 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 points based reward mechanism, and providing certain services or products
under preferred terms and benefits at other businesses that would join the Loyalty Plan as
secondary businesses. In addition, through the Loyalty Plan the Company may provide other
services such of personal finance and insurance products.

During
the High Holiday and Passover seasons, we run gift certificates programs, under which we
issue and sell gift certificates to institutions, companies and individuals. The gift
certificates 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. 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. We endeavor to keep the
website up to date with the same discounts that are available at our Super Center stores.
Currently, the service is provided in limited geographic areas, mainly in Central Israel
and in Jerusalem. It is our intention to expand the geographic areas to which the service
is provided.

# Government Regulation

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 for more information.

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The
Israeli government is authorized to control the retail and wholesale prices of goods and
services offered in Israel. At present, some of the products we offer in our stores,
including bread, flour, eggs, milk and margarine are subject to government-imposed price
controls. Recently, a new requirement has been imposed requiring bread suppliers to sell
certain basic bread to retailers, such as the Company, at certain fixed prices
(from May 2006 for an initial period of six months). As a result of this fixed wholesale
price arrangement, together with the maximum retail price that we are permitted to charge
our consumers for these basic breads, our profit margin for these breads has
effectively been narrowed. 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 to effect on our operating results for more
information.

Deposits
for Drink Containers

A
law effective October 1, 2001 requires stores 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 parliament, is considering an amendment to this law
which, among other things: (i) 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;
(ii) would limit to 50 the number of containers which a store is required to accept from
any customer on any single day; (iii) would impose the obligation to recycle the
containers on the producers and/or the importers of the containers and (iv) would impose
an affirmative duty on employers to supervise and to use their best efforts to prevent
violations of the law by their employees. Under the proposed amendment, an employer may be
held criminally liable for breaching its duty to prevent employee violations of the law.
See Item 3. Key Information  D. Risk Factors  The proposed amendment to
the Law of Deposits on Beverage Containers, 1999, would impose significant expenses and
costs on us, which could have a material adverse effect on our results of
operations.

Blue
Square is no longer a participant in the activities of a recycling corporation whose
purpose is to set up and operate a mechanism to implement the provisions of the law. We
have commenced a lawsuit against the recycling corporation for the reimbursement of
expenses that the recycling corporation was obligated to reimburse Blue Square under the
agreement between the founders of the recycling corporation and the recycling corporation.
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. For information regarding a claim under the new law, See
Item 8. Financial information- A. Consolidated Statements and Other Financial
Information  Legal Proceedings.

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.

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In
March 2003, the Israeli Antitrust Authority notified us that the previous agreement
between a subsidiary and another party with respect to a partnership at Malcha
Shopping Center branch constitutes a restrictive arrangement. Prior to the
aforementioned notification, the partnership was dissolved through the acquisition of the
other partys share of the partnership by our subsidiary. We are presently unable to
estimate the effect of the notification of the Israeli Antitrust Authority and its
ultimate outcome.

Interchange
Commission Rates

As
a condition to its acceptance of certain of the trade practices of the Israeli credit card
companies regarding the interchange commission (amount paid by one credit card company to
another for clearing the charges made by customers of the paying credit card company), the
Israeli Antitrust Authority has demanded that Israeli credit card companies narrow the
interchange commission rates charged in respect of different retailers. As a result, the
commission that credit card companies charge us was increased substantially, and a one
percent standard commission rate to all food establishments was set. This action of the
Israeli Antitrust Authority is being challenged in the Israeli Court of Restrictive Trades
by other retailers. We cannot predict the outcome of this challenge.

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 interrogated.

On
May 29, 2003, the Commissioner of the Israeli Antitrust Authority announced that it had
concluded its investigation of the above issue. The Commissioner of the Israeli Antitrust
Authority notified us that due to the findings, the Israeli Antitrust Authority is
considering taking enforcement actions against those who had violated the law. In
addition, the Commissioner publicized a document of direction, which contained his
view of the legality of certain commercial conduct between the large supermarket chains
(which then consisted of Super Sol, ClubMarket and us) and the large suppliers, which was
exposed during the investigation.

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. The Commissioner announced the following operational measures to enforce the law:

| | The
legal department of the Israeli Antitrust Authority is to take appropriate legal
proceedings against any party to a clear violation of the law exposed during the
investigation and, if necessary, take prospective legal measures, such as injunctions and
issuing directives to monopolists.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | Demand
from the relevant supermarket retail chains and food suppliers to provide all existing
agreements and arrangements with regard to year 2004 in order to ensure that the illegal
practices have ceased and that the recommendations of the Commissioner have been
implemented.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | To
review the practices and customs between the dominant suppliers and other supermarkets
(i.e., which are not among the major supermarket retail chains) in order to confirm the
legality of these arrangements under the antitrust laws.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The main directions in the final
position document were the following:

| |  | Arrangements
by which suppliers influence the setting of the number, identity or the extent of
competing suppliers presence at such retail chain are proscribed restrictive
arrangements according to the Commissioner.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Acquisition
of retail display area by suppliers is not illegal per se, but rather depends on
the circumstances.
| | - | ----------------------------------------------------------------------------------------------------------------

| |  | Category
management by a dominant supplier must be subject to the review of antitrust authorities
review. Category management by a retail chain with a supplier constitutes a restrictive
arrangement, but is not completely proscribed and will be reviewed by the antitrust
authorities on a case-by-case basis.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
use of suppliers representatives to physically arrange the shelves in the chains stores
constitutes a restrictive arrangement.
| | - | ------------------------------------------------------------------------------------------------------------------------------------

| |  | Discounts
and rebates in exchange for meeting sales targets. The Commissioners position is
that the benefits granted to retailers by suppliers for attaining suppliers sales
targets may reduce or prevent competition and therefore proscribed. The Commissioner
stated that such system constitutes a type of target discountor loyalty
discount, as opposed to legitimate volume discount. However, the
Commissioner noted that under certain circumstances no enforcement will be executed for
such arrangements.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Commissioner considered to be a restrictive trade arrangement those arrangements between
a large retail chain and a dominant supplier where the supplier is guaranteed that its
market share in various product categories will remain above a certain percentage.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Commissioner deemed prohibited agreements between a supplier giving a discount and retail
chain under which either (i) the retail chain agreed not to permit a competing supplier
to hold a sale at the same time on a competing product or (ii) the supplier agrees not to
offer a similar sale to a competing retailer. However, the Commissioner added that giving
a reasonable preference in display areas to one supplier while its products and the
products of its competitors are both on sale may be justified under some circumstances.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | The
Commissioner deemed agreements between a supplier and a retail chain relating to the
price to be charged to consumers for the suppliers products to be proscribed
restrictive arrangements.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Commissioners position is that it is prohibited for a retail chain, when a
competing chain in close geographical proximity is selling a product at a lower price, to
lower the price of its own comparable product and charge the supplier for the difference.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Commissioner permitted the exchange of information between the supermarket chains and
their suppliers so long as it is done on a transparent and equal basis.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Commissioner declined to intervene with the retail chains practices relating to
their private label, as was requested by the suppliers.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

It
should be noted that the Commissioner of the Antitrust Authority findings do not refer
specifically to the Company.

After
the publication of the final 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 adopted by us.

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. We and the other major chains held a few meetings with the Commissioner with
respect to his final position document and the contents of the proposed consent decree;
however, we did not reach to an understanding and the negotiations have ceased. 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.

During
December 2005, the Commissioner issued a draft of consent decree (the Draft),
which was later submitted to the Restrictive Trade Practices Court for approval. The Draft
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 Draft addresses the following arrangements:

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| |  | 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 Draft, 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 Draft).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Whereas
in final 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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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 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 posseses 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

30

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| |  | 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
draft of 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 proposed consent decree; however, it could nevertheless have
an effect on the practices of the Companys suppliers.

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. As a result, we
expect to be charged in connection with discrepancies between the prices appearing on
products, and the prices charged by the cash register at the point of sale. These
discrepancies are the result of human error by personnel responsible for labeling our
products. In any event, we are making our best 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.

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, pursuant to recent amendment of the Consumer Protection Law, we are
obligated to post our merchandise return policy in our stores. The amendment also
addresses the requirements of location, details, size and shape of the notice of such
policy.

31

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In
addition, in February 2006, new regulations were promulgated under the Consumer
Protection Law, which regulates the warranty and post-sale services of certain
electrical appliances. Under the regulations, sellers of new electrical appliances 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. The regulation shall become effective within 180 days following
their publication in February 2006.

Following
the collapse of the Clubmarket chain, a private bill (proposed legislation) was submitted
to the Knesset according to which a seller (as defined under the Consumer Protection
Law)may not sell gift certificates in excess of NIS 100,000 (approximately $20,000)
unless such seller deposits with the Director of Consumer Protection a guaranty in total
value of the gift certificates, for the assurance of the gift certificate redemption.

In
2006, the Class Actions Law(the Law) was enacted (which codified prior
existing class actions arrangements, including under the Consumer Protection Law).
Under the 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.

Drugstores

Fifteen
of our supermarkets include drugstores, which sell, among other products, prescription and
non-prescription medicines. Under the Pharmacy Ordinance, 1981 and the regulations
promulgated thereunder, we are subject to requirements relating to the storage, packaging
and administration of drugs, storage of poisonous products, supervision requirements,
sanitary conditions, marketing of controlled substances, requirements relating to medical
devices, documentation requirements and other related requirements relating to the
operation of drugstores. In addition, each drugstore must be supervised and managed by a
licensed supervisor pharmacist. We employ in our drugstores supervisor
pharmacists, pharmacists and pharmacist assistants, all of whom have the required
licenses.

32

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Under
the Pharmacists Regulation (Sale of Preparation without Prescription not in Pharmacy or
by Pharmacist), over-the-counter pharmaceutical medical products (OTC
drugs) may be sold by individuals other than pharmacists and in places other than
drugstores. We are subject to certain obligations and requirements regarding the sale of
OTC drugs in our stores, among them: appointment of a supervisor in each store that sells
OTC drugs, requirements relating to the size, composition, sanitation, temperature and
safety of the stores selling OTC drugs, storage requirements, signage requirements,
maximum selling quotas to individual consumers, restrictions on sales to minors,
restrictions on advertising and promotion and requirements to pay license and renewal
fees.

New
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) 
2004, 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 impose significant expenses and costs on us if it were
become effective.

| | C. | Organizational
Structure
| | -- | ------------------------

We
operate all of the supermarkets, including 104 of the supermarkets that are directly owned
by Blue Square, and the remaining supermarkets which are owned by BSIPs
subsidiaries. Stores owned by BSIPs subsidiaries generated approximately 65% of our
sales during 2005. Each of BSIP and its 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 company, 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
BSIP, which is publicly traded on the Tel Aviv Stock Exchange, the board of directors must
include 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.

33

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Our
largest subsidiary is BSIP, of which Blue Square owned approximately 80.7% of the
outstanding shares as of December 31, 2005. The balance of BSIPs outstanding shares
are publicly held and traded on the Tel Aviv Stock Exchange. BSIP, in turn, owns all of
the outstanding shares of Hyper Hyper, which, as indicated in the table set forth below,
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. See Item 7. Major
Shareholders and Related Party Transactions  B. Related Party Transactions.
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 material holdings as of June 15, 2006. The company marked
with an asterisk (*) is not consolidated in our financial statements.

|Company (1)                                | Operations +                          | % Ownership Held
by Blue Square
|------------------------------------------ | ------------------------------------- | -------------------------------
|
|
|
|
|The Blue Square Chain Investments &        |                                       |                                
|Properties Ltd.                            | Real estate and supermarkets          | 80                             
|The Blue Square Chain (Hyper Hyper) Ltd.   | Supermarkets                          | 80                             
|Blue Square Real Estate Ltd.               | Real estate                           | 100                            
|Radio Non Stop Ltd.*                       | Local radio station                   | 26                             
|Hamachsan Hamerkazi Kfar Hasha'ashuim Ltd. | "All for a Dollar", toy and houseware |                                
|                                           | stores                                | 50                             

| | (1) | All
companies are incorporated under Israeli law.
| | --- | -------------------------------------------------

| | (2) | The
remaining shares of BSIP are held by the public and institutional investors
               and traded on the Tel Aviv Stock Exchange.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------

| | (3) | BSIPs
wholly owned subsidiary.
| | --- | -------------------------------

| | (4) | 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.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | + | We
are also a 50% owner in a 17,000 square meter shopping mall in Jerusalem (through BSRE).
| | - | -------------------------------------------------------------------------------------------

34

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| | D. | Property,
Plants and Equipment.
| | -- | -------------------------------

As
of December 31, 2005 we owned or leased approximately 507,000 square meters of space. The
following table provides certain details regarding the properties that we own and lease.

|Properties                                                         | Number | Space (sq. meters)(1)
|------------------------------------------------------------------ | ------ | ---------------------
|
|
|
|
|Total Existing Stores                                              |        |                      
|Owned  (including long term lease from Israel Land Administration) |        |                      
|Leased under 5 years                                               |        |                      
|Leased between 6-10 years                                          |        |                      
|Leased over 10 years                                               |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|Stores in Development                                              |        |                      
|Owned                                                              |        |                      
|Leased between 5-25 years                                          |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|Owned Offices (Rosh Ha'ayin, Givataim)                             |        |                      
|Owned Warehouses (Rishon Letzion, Kiriat Gat, Kfar Saba)           |        |                      
|Leased Warehouses (Barkan)                                         |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|Undeveloped Land (1)                                               |        |                      
|                                                                   |        |                      
|Leased to Third Party (2)(3)                                       |        |                      
|                                                                   |        |                      
|Unutilized Properties                                              |        |                      
|                                                                   |        |                      
|                                                                   |        |                      
|TOTAL                                                              |        |                      
|                                                                   |        |                      

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

| | (2) | Including
a 50% interest owned by Blue Square 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
2006, we opened and plan to open (including by way of acquiring ex- Clubmarket stores)
approximately nine additional supermarkets, totaling approximately 15,600 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, 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 100 million, or $22 million, on the acquisition and development of new
supermarkets and the remodeling of our existing supermarkets through the end of 2006.

35

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Most
of our acquisitions of real estate have been in connection with the retail operation of
our stores. Nevertheless, through our Real Estate Development Division, we are exploring
various alternatives to maximize the potential value of our real estate assets, including
our unused building rights. Recently, we transferred our real estate assets (excluding
real estate owned by BSIP and its subsidiaries) and certain liabilities (including lease
agreements with third parties and with BSIP) to a new wholly owned subsidiary (BSRE) that
will manage approximately 146,000 square meters currently occupied by Blue Squares
stores and other lessees, as well as the unoccupied land and unused building rights previously under
Blue Squares ownership, with the goal of seeking ways to maximize their value. The
Board of Directors of BSRE has recently approved the filing of a draft prospectus for an
initial public offering (IPO) on the Tel Aviv Stock Exchange. There is no guarantee that
BSRE will in fact complete such an offering.

For
further information regarding our real estate, please see Item 4. Information on The
Company  B. Business Overview  Real Estate.

We
also have begun to construct a gasoline station to be operated by us on one of our
properties, and we are currently examining the feasibility of establishing and operating
additional gasoline stations on other properties.

|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.

General

The
year 2005 saw a continuation of Israels improved economic environment, as well as
our growth reflected in steadily rising revenues and same store sales. This resulted from
an improved economy, intensified marketing, consolidation of our store formats into three
well-differentiated brands and increase in our efficiency.

36

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In
recent years, due to a recession and an increase in unemployment in Israel, the most
important factor in the purchase decisions of a larger portion of the Israeli public has
been the price of the products it purchases. Even following the improved economic
environment during 2005, the price of products has remained a significant factor in the
purchase decisions of many consumers. At the same time, during 2005, there was an increase
in sales made by the local neighborhoods and city centers stores (which are relatively
more expensive stores). Such increase may suggest that, for part of the consumers, there
has been a change in their buying patterns, i.e., preferring convenience and
geographical proximity to the lower prices of supermarket stores.

In
response to the increased focus on the price of products, private supermarkets have
continued to expand their presence in selected areas, increasing competition in an already
difficult market, although the growth in market share of such private supermarkets slowed
during 2005. These private supermarkets 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 operate on Saturdays. We and other major chains
have also responded to consumers increased focus on the price of products by
continuing our expansion into low-price store formats, and other major chains have
expanded into hard discount store formats.

Over
the last few years, in order to lower our costs and meet the challenges posed by our
competition, including private supermarkets, we have implemented an efficiency plan. This
plan, has included among others, dismissal of employees and reduction in our electricity,
communications, security, cleaning and laundry costs and efforts to reduce inventory
shrinkage. We intend to continue our efforts to reduce operating costs in the future,
although the potential for additional savings has been reduced.

During
2005 we completed the process of streamlining our store brands to just three  Mega,
Super Center and Shefa Shuk  in order to increase the effectiveness of our marketing
investments and differentiate our store brands. In planning the mix of our stores, we have
taken a regional view, with the goal of bringing all three of our store brands within the
shopping range of every Israeli consumer. As expected, the conversion of higher-priced
stores to lower-margin formats has impacted our gross margins, but we were partially
compensated in 2005 by increases to our regional sales volumes. Furthermore, pursuant to
organizational changes instituted in 2005, we began to operate our three store formats as
autonomous divisions. As a result of these organizational changes, corporate-level
marketing and operations roles were incorporated into our three store divisions. The goal
has been to eliminate corporate-level personnel, while at the same time improving the
performance of our individual store formats.

We
are increasing the variety of products sold in our stores in two categories:
Non-Food items such as housewares, toys, entertainment and leisure products,
small electrical appliances, computers and computers accessories and textile products, and
Near-Food items such has health and beauty aids, toiletries, cleaning
products, paper goods and baby supplies. These items carry higher average margins than our
food items and increase the portion of our customers shopping needs that are
addressed in our stores. As part of this strategy, in 2005 we acquired 50% of the holdings
of Hamachsan Hamerkazi Kfar Hashaashuim Ltd. (Central Warehouse/Toy
Village)", Israels largest franchiser of All for a Dollar, toy and
houseware stores. In addition, we sell over the counter pharmaceutical medical products to
further expand the mix of goods sold in our stores.

37

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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,
|------------------------------------------------ | -----------------------
|
|
|
|
|Sales                                            |                        
|Gross profit                                     |                        
|Selling, general and administrative expenses     |                        
|Operating income                                 |                        
|Taxes on income                                  |                        
|Minority interest in profit of subsidiaries, net |                        
|Net income (loss)                                |                        

Year Ended December 31, 2005
compared with year ended December 31, 2004

SalesSales in 2005 were approximately NIS 5,797 million, or $1,259.4 million, an increase
of approximately 8.0% compared with sales of approximately NIS 5,366 million in 2004. The
growth in sales derived from:

| |  | The
opening of seven stores during 2005, increasing the Companys sales area by 12,000
square meters.
| | - | -----------------------------------------------------------------------------------------------------

| |  | The
contribution of Kfar Hashaashuims sales for the year, increasing the Companys
revenues by NIS 90.8 million (approximately U.S. $19.7 million) in the third and fourth
quarters of 2005, following the consolidation of Kfar Hashaashuims financial
statements into the Companys financial statements;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
increase of Non-Food sales in Blue Square stores due to the collaboration with Kfar
Hashaashuim;
| | - | ----------------------------------------------------------------------------------------------------

| |  | The
collapse of the Clubmarket chain, which led to a temporary increase in the number of
shoppers in the Companys stores in the third quarter;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
success of the Company's brand consolidation program and marketing initiatives; and
| | - | ---------------------------------------------------------------------------------------

38

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| |  | Stronger
redemption of gift certificates as compared to 2004.
| | - | -------------------------------------------------------------

Gross
profit. Gross profit in 2005 was approximately NIS 1,498.8 million, or $325.6 million,
an increase of 6.8% compared with gross profit of approximately NIS 1,403 million in 2004.
This increase in gross profit reflected the higher level of sales mitigated by a decrease
in the gross margin to 25.9% in 2005 compared to 26.2% in 2004. The decrease in margin
reflected:

| |  | An
 increase  in the  proportion  of  discount  sales in the  overall  sales  mixture  due
to the                     Company's consolidation program;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Strong
competition throughout the Company's markets;
| | - | ----------------------------------------------------

| |  | An
increase in discounts  associated  with the  redemption of gift  certificates  during
 holiday                     seasons; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------

| |  | Offset
partially by better terms from suppliers and better pricing policies.
| | - | ----------------------------------------------------------------------------

Selling,
general and administrative expenses. Selling, generaland administrative
expenses in 2005 were approximately NIS 1,269.8 million, or $275.9 million, an increase of
5.5% compared with selling, generaland administrative expenses of approximately
NIS 1,203.4 million in 2004. This increase reflected:

| |  | Expenses
of new stores opened during the prior 12 months;
| | - | ---------------------------------------------------------

| |  | Aggressive
advertising and marketing campaigns carried out during the year;
| | - | ---------------------------------------------------------------------------

| |  | A
significant increase in electricity and energy expenses; and
| | - | --------------------------------------------------------------

| |  | An
increase in CPI (Consumer Price Index)-related expenses.
| | - | -----------------------------------------------------------

However,
as a percentage of revenues, expenses declined to 21.9% of sales from 22.4% in 2004.

Operating
income. Operating income in 2005 was approximately NIS 229 million, or $49.8 million,
an increase of 14.5% compared with approximately NIS 200 million in 2004, resulting in an
operating margin for the year of 4.0% compared to 3.7 % in 2004. The increase in operating
income reflects the increased revenues and gross profit for the period, mitigated somewhat
by increased selling, general and administrative expenses.

Financial
expenses, net. Financial expenses, net in 2005 were approximately NIS 59.5 million, or
$12.9 million, compared with financial expenses of approximately NIS 58.1 million in 2004.
This change reflected:

39

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| |  | Increase
in financial expenses of long term loans and debentures from NIS 59.5 million in 2004 to
NIS 66.5 million in 2005. This increase resulted from the increase in linkage costs in
connection with our debentures due to the increase in CPI in 2005 offset somewhat by a
decrease in linkage costs of a loan linked to the Swiss Frank.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Increase
in interest income, net of short-term credit, bank commissions and other from NIS 0.7
million in 2004 to NIS 7 million in 2005 mainly due to an increase in financial income
from advance payments to suppliers.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other
income (expenses), net. Other income, net in 2005 was approximately NIS 0.7 million,
or $0.15 million, compared with other expenses, net of approximately NIS 20 million in
2004. The 2005 other income consisted primarily of the following:

| |  | a
 capital  gain of NIS  2.3  million  (U.S.  $0.5  million)  related  to the  sale of one
of the                   Company's subsidiaries; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | NIS
0.7 million  (U.S.  $0.15  million) in respect of capital  gains  resulting  from the
sale of                   fixed assets,
| | - | ---------------------------------------------------------------------------------------------------------------------------------

offset
by:

| |  | a
provision of NIS 2.7 million (U.S. $0.6 million) in connection with the closure of stores.
| | - | --------------------------------------------------------------------------------------------

Other expenses for 2004 consisted
primarily of the following:

| |  | a
provision of NIS 8.4 million in respect of the impairment of assets, in accordance with
Israel Accounting Standard No. 15 (Impairment of Assets), and the closure of stores;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | NIS
4.7 million related to dismissal of employees from the Company's headquarters; and
| | - | --------------------------------------------------------------------------------------

| |  | NIS
4.5 million as a compensation payment for the termination of a private label contract.
| | - | ------------------------------------------------------------------------------------------

Taxes
on income. Taxes on income in 2005 were NIS 58.5 million, or $12.7 million, compared
with approximately NIS 41.2 million in 2004. As a percentage of income before taxes on
income, taxes on income increased to approximately 35.7% in 2005, compared with 35.4% in
2004. This reflected principally a decrease in tax deduction (from approximately NIS 3.0
million in 2004 to approximately NIS 0.2 million (U.S. $0.04 million) in 2005). This
deduction results from the difference between measurement of income reported for tax
purposes (which is calculated on the basis of changes in CPI) and the basis of measurement
of income for financial reporting purposes (in nominal values, commencing January 1,
2004). The increase was offset partially by the reduction of the Companys nominal
tax rate in line with amendments to the Income Tax Ordinance that were enacted in July
2004 and August 2005 that provide for a gradual reduction in the rate of corporate tax. As
a result, the Companys corporate tax rate was reduced from 35% in 2004 to 34% in
2005, and will be reduced during the next five years as follows: 2006  31%; 2007
 29%; 2008  27%; 2009  26%; 2010 and thereafter  25%.

40

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Minority
interest in profit of subsidiaries, net.Minority interest in profit of
subsidiaries, net in 2005 was approximately NIS 15.7 million, or $3.4 million, an increase
of 15.9% compared with approximately NIS 13.6 million in 2004. This increase in minority
interest in profit of subsidiaries, net is primarily attributable to the increase in the
net income of BSIP in 2005.

Net
income.Net income in 2005 increased by 48.6% to NIS 90.0 million, or
$19.5 million (NIS 2.32 or $0.50 per ADS) compared with a net income of approximately NIS
60.5 million in 2004 (NIS 1.57 or $0.34 per ADS).

Year Ended December 31, 2004
compared with year ended December 31, 2003

Sales.          Sales
in 2004 were approximately NIS 5,366 million, an increase of approximately           3.8%
compared with sales of approximately NIS 5,171 million in 2003. This           increase
in sales reflects the success of the Companys brand consolidation           and
expansion programs during the year. Over the course of the year, we           converted
all stores into three well-differentiated brands: Mega, SuperCenter           and Shefa
Shuk.

Gross
profit. Gross profit in 2004 was approximately NIS 1,403 million, an increase of 0.7%
compared with gross profit of approximately NIS 1,393 million in 2003. This increase in
gross profit reflected the higher level of sales mitigated by a decrease in the gross
margin to 26.2% in 2004 compared to 26.9% in 2003. This reflects an increase in discounted
sales as a percentage of the overall sales mixture due to the Companys brand
consolidation program, especially the conversion of Co-Op stores to Super Centers and
Super Centers to Megas and Shefa Shuks, offset somewhat by improved buying terms with
suppliers.

Selling,
General and administrative expenses. Selling General and administrative expenses in
2004 were approximately NIS 1,203 million, an increase of 1.1% compared with operating and
administrative expenses of approximately NIS 1,190 million in 2003. This increase is
attributable to the Companys addition of new stores during the year. However,
Selling, General & Administrative Expenses (SG&A) declined as a percentage of
revenues to 22.4% from 23.0% in 2003. This illustrates the ongoing success of the
Companys efficiency efforts.

Operating
income. Operating income in 2004 was approximately NIS 200 million, a decrease of 1.3%
compared with approximately NIS 203 million in 2003, resulting in an operating margin for
the year of 3.7% compared to 3.9% in 2003. The decrease in operating income and operating
margin was due to a decrease in gross margin offset somewhat by a decrease in expenses.

41

---

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Financial
income (expenses), net. Financial expenses, net in 2004 were approximately NIS 58
million, compared with financial expenses, net of approximately NIS 49 million in 2003.
The higher level of financial expenses for 2004 reflects increased total debt following
the Companys issuance of debentures in August 2003 and the increased dividend
payments during the year (which the Company financed partially by increasing its debt), a
reduction in income from the revaluation of marketable securities and interest income from
short-term deposits. These were partly offset by a reduction in financial expenses due to
the termination of adjustments for the effects of inflation following the introduction and
effectiveness of Israel Accounting Standard No. 12.

Other
expenses, net. Other expenses, net in 2004 were approximately NIS 20 million, compared
with other expenses, net of approximately NIS 137 million in 2003. The 2004 charges
consisted primarily of the following:

| |  | a
 provision  of NIS 8.4  million in respect of the  impairment  of assets,  in  accordance
 with                 Israel Accounting Standard No. 15 (Impairment of Assets), and the
closure of stores;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | NIS
4.7 million related to dismissal of employees from the Company's headquarters; and
| | - | --------------------------------------------------------------------------------------

| |  | NIS
4.5 million as a compensation payment for the termination of a private label contract.
| | - | ------------------------------------------------------------------------------------------

Other
expenses for 2003 consisted primarily of the following:

| |  | a
one-time expense of NIS 63.9 million recorded in the second quarter of 2003, related to
agreements reached between Blue Square and its employees after the change in control of
the Company, according to which Blue Squares employees were entitled to receive
certain one-time bonuses and additional future benefits;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
provision of NIS 49.2 million in respect of impairment of fixed assets and the costs of
closure of unprofitable stores (lease termination costs and others); and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
provision of approximately NIS 26 million in respect of the dismissal of approximately
250 employees as a result of an adoption of an efficiency plan by the Company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
Israeli GAAP the above expenses can be classified as other expenses. However,
under U.S. GAAP these expenses are classified as operating expenses, see note 18 (a)(12)
to the financial statements.

42

---

---



Taxes
on income. Taxes on income in 2004 were NIS 41.2 million, compared with approximately
NIS 8.4 million in 2003. As a percentage of income before taxes on income, taxes on income
decreased to approximately 35.4% in 2004, compared with 73.4% in 2003. This higher
effective tax rate applicable to us in 2003 primarily resulted from our incurrence of a
significantly higher amount of non-deductible expenses in 2003 resulting mainly from the
operation of Accounting Standard No. 15, Impairment of Assets. In 2004, the
Companys nominal tax rate was reduced from 36% to 35% in accordance with the Income
Tax Ordinance Amendment adopted on June 29, 2004, which provides for the gradual reduction
in the rate of corporate tax commencing from January 1, 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%.

Minority
interest in profit of subsidiaries, net.Minority interest in profit of
subsidiaries, net in 2004 was approximately NIS 13.6 million, an increase of 24.9%
compared with approximately NIS 10.9 million in 2003. This increase in minority interest
in profit ofsubsidiaries, net is primarily attributable to the increase in the net
income of BSIP in 2004.

Net
income.Net income in 2004 was approximately NIS 60.5 million, compared
with a net loss of approximately NIS 7.0 million in 2003.

# 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, 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.

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. Until periods beginning on or
after January 1, 2004, our financial statements were presented in NIS adjusted to reflect
changes in the Israeli consumer price index, or the CPI.

|               | Net sales | Operating income
|-------------- | --------- | ----------------
|
|
|
|
|2005           |           |                 
|First quarter  |           |                 
|Second quarter |           |                 
|Third quarter  |           |                 
|Fourth quarter |           |                 
|               |           |                 
|2004           |           |                 
|First quarter  |           |                 
|Second quarter |           |                 
|Third quarter  |           |                 
|Fourth quarter |           |                 

43

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# Exchange Rates

At
December 31, 2005, the representative rate of exchange of the NIS to the dollar, as
published by the Bank of Israel, was NIS 4.603 = $1.00.At June 15, 2006, the
representative rate of exchange of the NIS to the dollar, as published by the Bank of
Israel, was NIS 4.46 = $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, 2001
through 2005:

|Year Ended
December 31, | Period End | Average Rate (1) | High | Low 
|----------------------- | ---------- | ---------------- | ---- | ----
|
|
|
|
|2001                    |            |                  |      | 4.42
|2002                    |            |                  |      | 4.74
|2003                    |            |                  |      | 4.38
|2004                    |            |                  |      | 4.31
|2005                    |            |                  |      | 4.60

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

The
following table sets forth certain information concerning the representative exchange rate
of the NIS to the dollar, as published for the months January through May 2006.

|Month    | Period End | Average Rate (1) | High | Low 
|-------- | ---------- | ---------------- | ---- | ----
|
|
|
|
|January  |            |                  |      | 4.66
|February |            |                  |      | 4.71
|March    |            |                  |      | 4.67
|April    |            |                  |      | 4.50
|May      |            |                  |      | 4.52

(1)    
          The average of the daily exchange rates.

# Impact of Inflation and
Currency Fluctuations

Inflation
in Israel increases our expenses, which, because of competitive pressures, are generally
not offset, fully or as quickly, by increases in our selling prices and revenues. In
addition, 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 NIS cost of these
goods.

44

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Although
substantially all of our revenues are received in NIS and a substantial majority of our
expenses is incurred in NIS, that portion of expenses which is attributable to goods that
are imported into Israel is incurred and payable in currencies other than NIS, especially
the Euro. As a result, our operating results are affected by exchange rate fluctuations of
the NIS vis-à-vis other currencies, especially the Euro. See also Item 11.
Quantitative and Qualitative Disclosure about Market Risks.

Beginning
January 1, 2004, our financial statements ceased to be adjusted for inflation in
accordance with Israeli Accounting Standard No. 12 adopted by the Israeli Accounting
Standards Board. As a result of the adoption of this standard, our assets and shareholders
equity ceased to be adjusted for inflation in Israel, while the repayment of interest and
principal under most of our loans and all debentures continues to be linked to the Israeli
CPI as provided in our loan and debenture agreements. 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.

# 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. Since October 2000, hostilities between Israel and
the Palestinians, including the Palestinian Authority, have substantially increased. These
hostilities include terrorist acts in Israel and military operations in the West Bank and
Gaza. Those hostilities had a negative effect on the Israeli economy. In January 2006,
Hamas, an Islamic movement responsible for many attacks against Israelis, won the majority
of the seats in the Parliament of the Palestinian Authority. The election of a majority of
Hamas-supported candidates is expected to be a major obstacle to relations between Israel
and the Palestinian Authority, as well as to the stability in the Middle East as a whole.
The future effect of the continuance of these hostilities on the Israeli economy and our
operations is unclear.

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.

45

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Some
of our officers and employees in Israel are obligated to perform up to 36 days of military
reserve duty annually, depending on rank and position, and are subject to being called for
active duty at any time under emergency circumstances. If a military conflict or war
arises, these individuals could be required to serve in the military for extended periods
of time. While we have operated effectively under these requirements since we began
operations, 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.

# Economic Conditions

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

All
of our sales are made in Israel and a substantial majority of the goods that we sell are
grown, manufactured or processed in Israel. Consequently, our financial performance is
dependent to a significant extent on the economy of Israel. During 2002, Israels
Gross Domestic Product declined by 1.2%, while in 2003, 2004 and 2005, it rose by 1.7%,
4.4% and 5.2%, respectively. The economic slowdown during 2002 and a portion of 2003
adversely affected our financial performance. Initial reports indicate that the Israeli
economy grew by 6.6% at the first quarter of 2006. We cannot be sure how any growth or
decline in the Israeli economy will affect our financial performance.

# 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 31% of our  taxable  income in 2006
(34% in 2005).

46

---

---



The
income of the Company and its subsidiaries is taxed at the regular rate. Through December
31, 2003, the corporate tax rate was 36%. 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% 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 2004 and thereafter are as follows: 2004  35%, 2005 
34%, 2006  31%, 2007  29%, 2008  27%, 2009  26% and for 2010 and
thereafter  25%.

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

# Critical Accounting
Estimates

We
prepare our consolidated financial statements in conformity with accounting principles
generally accepted in Israel and include reconciliation to accounting principles generally
accepted in the United States. In preparing our financial statements, we are required to
make certain estimates, judgments and assumptions that we believe are reasonable based
upon the information available. These estimates and assumptions affect the reported
amounts of assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the periods presented. To fully understand and
evaluate our reported financial results, we believe it is important to understand the
following estimates and judgments we use in applying our accounting policies:

Impairment
of Assets

Effective
December 31, 2002, we apply Accounting Standard No. 15, Impairment of Assets.
The Standard prescribes the accounting treatment and disclosure for impairment of assets.
The Standard requires a periodic review to evaluate the need for a provision for the
impairment of the Companys non-monetary assets  fixed assets and identifiable
intangibles, including goodwill, as well as investments in associated companies. According
to the new Standard, if there is any indication that an asset may be impaired, we
determine if there has been an impairment of the asset by comparing the carrying amount of
the asset to its recoverable amount. Recoverable amount is defined as the higher of an
assets net selling price and its value in use. Value in use is the present value of
estimated future cash flows expected to be generated by the continuing use of an asset and
by its disposal at the end of its useful life. If the carrying amount of an asset in the
balance sheet exceeds its recoverable amount, an impairment loss should be recognized for
the amount by which the carrying amount of the asset exceeds its recoverable amount. The
impairment loss is carried directly to statements of operations. Where indicators present
that beneficial events have occurred or beneficial changes in circumstances have taken
place, the impairment provision in respect of the asset (other than goodwill) may be
cancelled or reduced in the future, so long as the recoverable value of the asset has
increased, as a result of changes in the estimates previously employed in determining such
value.

47

---

---



We
evaluate impairment separately for each store or other cash-generating unit. 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 to other units. Goodwill is evaluated for
impairment in relation to the cash generating unit to which the goodwill can be allocated;
mostly, goodwill is allocated to the operations of the Companys principal
consolidated subsidiary, BSIP.

The
recoverable amount of the cash generating units is determined, in part, by value in use
and, in part, by net selling price. In determining the value in use of an asset, we use
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. The current
discount rate used by us is 8% (before taxes). We rely on independent experts to determine
the appropriate discount rate. In determining the net selling price of an asset,
management relies on estimates of internal experts.

The
results of impairment tests are subject to managements estimates and assumptions of
projected cash flows, operating results and the discount rate to be used in discounting
projected cash flows. We estimate future cash flows based on our experience and knowledge
of the market in which the stores are located as well as on external experts. However,
these estimates project cash flow several years into the future and are affected by
variable factors such as inflation, the strength of the real estate markets and economic
conditions. A change in assumptions or market conditions could result in a change in
estimated future discounted cash flows and the likelihood of materially different reported
results.

According
to U.S. GAAP (SFAS 144  Accounting for the Impairment or Disposal of
Long-Lived Assets) an impairment loss is recognized only if the carrying amount of
an asset is not recoverable. The carrying amount is not recoverable if it exceeds the
estimated undiscounted future cash flows expected to result from the use of the asset. If
the carrying amount is not recoverable, an impairment loss should be recorded for the
amount by which the carrying value of the asset exceeds its fair value. As a result,
certain circumstances which would require an impairment loss to be recorded under Israeli
GAAP would not require an impairment loss to be recorded under U.S. GAAP. Under US GAAP
this impairment loss cannot be restored, and the asset is continued to be carried in its
new cost.

Rebates
from suppliers

Current
rebates from suppliers are recorded in the financial statements upon receipt.

Rebates due
from suppliers for which we have no obligation to meet certain targets are recorded in the
financial statements as purchases from these suppliers are made.

48

---

---



We
are also entitled to certain rebates upon meeting certain targets. The rebates are
recognized in the financial statements as earned on a pro rata basis based on a systematic
calculation of the extent to which we have reached the target, provided it is probable
that the final target will be met and the total rebate can be reliably estimated.
Estimates as to whether the final target will be met are based, among others, on past
experience, our relationship with the supplier, and the amount of the anticipated
purchases for the remaining period. Rebates from suppliers are presented as a reduction of
inventories and cost of sales, as applicable. The effect of our estimate is more
significant on our quarterly financial statements. At year-end upon achievement of final
targets, we adjust the interim estimates according to the actual results of the targets.

Inventory

We
value our inventories using the first-in, first-out (FIFO) method for all of
our stores.

We
provide for estimated inventory losses (shrinkage) between physical inventory counts on
the basis of percentage of sales. The provision is adjusted annually to reflect the
historical trend of the actual physical inventory count results on a store-by-store basis.
Historically, shrinkage has not been volatile.

We
reduce the value of our inventory annually on a percentage basis based on the rebates that
we receive from our suppliers.

Compensation
for Unutilized Sick Leaves

We
record as an expense in the financial statements our employees unutilized sick
leaves. These expenses are recorded in the financial statements based on estimates that we
receive from an independent actuarial, who makes estimates based on variety of factors,
including retirement age and interest rates.

Critical
Accounting Policies

To
fully understand and evaluate our reported financial results, we believe it is important
to understand the following accounting policies:

Goodwill

Goodwill,
under Israeli GAAP, is presented at cost and is amortized over the estimated period of
benefit of 10 and 20 years (mainly 20 years) commencing in the year of acquisition.
Goodwill is reviewed for impairment when circumstances indicate the possibility that
impairment exists.

According
to accounting Standard No. 20 (Amended)  The Accounting Treatment of the
Goodwill and Intangible Assets on the Acquisition of Investee Companies, effective
as of January 1, 2006, goodwill and intangible assets that are identified as having an
infinite life are no longer amortized; instead, an annual (or more frequent) impairment
test of these assets is required to be performed in order to establish the existence of
events or circumstances indicating a possible impairment in the value of such assets.

49

---

---



Under
U.S. GAAP (SFAS 141 and SFAS 142  goodwill that arose from acquisitions prior to
July 1, 2001 was amortized until December 31, 2001, on a straight-line basis over the
estimated period of benefit and thereafter is no longer amortized. Goodwill is to be
tested for impairment on adoption of SFAS 142 and at least annually thereafter or between
annual tests in certain circumstances, and written down when impaired. Goodwill is tested
for impairment on the reporting unit level. Goodwill attributable to a reporting unit is
tested for impairment by comparing the fair value of the reporting unit with its carrying
value. Fair value is determined based on market value of the reporting unit. The reporting
unit to which most of the goodwill was attributed is a subsidiary, whose shares are traded
on the Tel-Aviv stock exchange, and therefore its fair value is determined based on its
shares market value.

Recently
issued accounting pronouncements in Israel and in the United States

|For
information on recently issued accounting pronouncements in Israel and in the United
States, see notes 2w and 18c to our consolidated financial statements.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------

# Liquidity and Capital
Resources

Sources
and Uses of Cash

Our
principal source of liquidity is the cash generated by our operations. Both Blue Square
and its partially owned subsidiaries have generally generated sufficient cash from their
operations to satisfy their respective operating requirements. The available cash
resources of BSIP and its 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 210 million in 2005, a decrease of 40%
compared with approximately NIS 349 million in 2004. This decrease in cash generated by
operations in 2005 was mainly due to:

| |  | a
decrease of approximately NIS 40 million in trade payables in 2005 compared with an
increase of NIS 115 million in 2004 resulting from a change in the payment date to
suppliers at the end of 2005 as opposed to payments dates at the end of 2004; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
increase in inventories in the amount of NIS 43 million in 2005 compared with an increase
of NIS 13 million in 2004 due to an increase in number of stores in 2005 compared with
2004, and the purchase of our inventory of Non-Food products in 2005.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

offset
by:

50

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| |  | net
cash flow from operating activities excluding change in working capital was NIS 274
million in 2005 compared to NIS 243 million in 2004.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

Cash
generated by operations amounted to approximately NIS 349 million in 2004, an increase of
35% compared with approximately NIS 259 million in 2003. The increase in cash generated by
operations in 2004 was mainly due to the following:

| |  | net
cash flows from operating activities excluding changes in working capital was NIS 243
million in 2004 compared to NIS 199 million in 2003;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
increase of approximately NIS 114 million in trade payables in 2004 compared with an
increase of NIS 28 million in 2003 resulting from a change in the payment date to
suppliers at the end of 2004 as opposed to payment dates at the end of 2003;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
decrease in trade receivables in the amount of NIS 4 million in 2004 compared with an
increase of NIS 22 million in 2003 resulting from an advance payment of NIS 80 million
made by credit card companies in 2004 following their agreement to spread their payments
to us more evenly during each month. As a result of this agreement, a portion of the
payments by the credit card companies to us are made earlier in the month, and a portion
later in the month. On the other hand, the amount owed by customers increased by
approximately NIS 50 million due to the higher sales in December 2004, compared to sales
in December 2003; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
increase in inventories in the amount of NIS 13 million in 2004 due to an increase in the
number of stores compared with a decrease in inventory of NIS 54 million in 2003 due to a
decrease in number of stores.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
2005, approximately 38.6% of our sales were paid for with cash and cash equivalents at the
point-of-sale, approximately 60.8% of sales were paid for with credit cards and
approximately 0.6% of sales were paid for with other short-term credit arrangements.

During
2005, the average time period that we held inventory was 27 days and the average time
period within which our accounts receivable were paid was 28 days. By contrast, as of such
date the average time period for payment of our accounts payable was 62 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 2005, we
received long-term borrowings of NIS 633.2 million, or $138 million. This amount includes
NIS 500 million, or $109 million, that we incurred in December 2005, as part of our
preparations for the transfer to BSRE, our wholly owned subsidiary, of real estate assets
and related financial obligations. The sum of the loan was deposited in a limited deposit
to secure the sum of the loan, and the Company has transferred the loan to BSRE at the
time of the transfer of the real estate assets to BSRE, while retaining the proceeds of
the loan. The Company currently intends to use the proceeds of the loan for investments,
for repaying of debts and for dividend distributions. See Item 4. Information on The
Company  B. Business Overview  Real Estate.

51

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During
2005, we repaid NIS 139.2 or $30 million, in long-term borrowings and received NIS 4.92
million or $1.1 million in short-term borrowings. In 2003, we issued NIS 400 million in
aggregate principal amount of unsecured 5.9% convertible and nonconvertible debentures
with installments of principal on the convertible debentures due in 2007, 2009 and 2011
and installments of principal on the nonconvertible debentures due in 2012, 2013 and 2014.

During
2005 and 2006, the following dividends were paid:

On
June 22, 2006, we paid a dividend of $0.17 per share in the amount of NIS 30 million or
approximately $6.7 million.

On
April 20, 2006, we paid a dividend of $0.27 per share in the amount of NIS 50 million or
approximately $10.7 million.

In
September 2005, we paid a dividend of $0.28 per share in the amount of NIS 50 million or
approximately $11 million.

In
January 2005, we paid a dividend of $0.23 per share in the amount of NIS 39 million or
approximately $9 million.

In
April 2005, BSIP paid a dividend totaling NIS 80 million or $18.6 million, approximately
NIS 65 million or $15 million of which was distributed to Blue Square, and approximately
NIS 15 million or $3.5 million was distributed to other shareholders. 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.
BSIP financed the distribution in part by bank financing. 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.

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
2005, we invested approximately NIS 89.1 million, or $19.3 million, in fixed and other
assets, in the development of new stores and in existing store renovation and remodeling,
a decrease of 0.4% compared with approximately NIS 89.4 million during 2004 which, in
turn, represented a decrease of 35.5% compared with approximately NIS 139 million during
2003. We currently plan to spend in excess of NIS 100 million, or $22 million for the
development or acquisition of new supermarkets, the renovation and remodeling of our
existing supermarkets and related investments through the end of 2006. We intend to
finance our store development, renovation, modeling, expansion and acquisitions mainly
from cash generated by our operations.

52

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In
addition, on May 8, 2005, we purchased 50% of the holdings of Hamachsan Hamerkazi
Kfar Hashaashuim Ltd. in consideration for NIS 3.2 million or approximately $0.7
million for ordinary shares and NIS 21.8 million or approximately $5 million in the form
of shareholder loans.

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)
|------------------- | ------------------------------------
|
|
|
|
|Long term loans     |                                     
|from banks (1)      |                                     
|Non-Convertible     |                                     
|Debentures (2) (3)  |                                     
|Convertible         |                                     
|Debentures (2) (4)  |                                     
|Non-cancelable Long |                                     
|term leases         |                                     
|                    |                                     
|Total contractual   |                                     
|cash obligations    |                                     

| | (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, variable interest
rates           or foreign currency 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, 2005 (5% per annum), interest
payments on           the long-term loans would be NIS 47,354 in 2006, NIS 9,309 in 2007,
NIS 3,531in           2008, NIS 1,550 in 2009 and NIS 101 in 2010 and thereafter.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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 would
be NIS 10,458 in 2006, NIS 8,054 in 2007, NIS 6,430 in 2008,           NIS 4,027 in 2009,
and NIS 2,403 in 2010. Without taking into account any           changes to the Israeli
CPI, interest payments on the Convertible Debentures           would be NIS 10,914 in
2006, NIS 9,447 in 2007, NIS 7,276 in 2008, NIS 5,809 in           2009, NIS 3,638 in
2010 and, NIS 2,171 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.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | The
principal is repayable in three equal annual installments on August 5 of           each
of the years 2012 to 2014. 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,
we           will not repay more than one third of the par value of the debentures
          outstanding as of that date. This table assumes early redemption of these
          debentures.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | The
principal is repayable in three equal annual installments on August 5 of           each
of the years 2007, 2009, and 2011.
| | --- | ------------------------------------------------------------------------------------------------------------------------------

53

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As
of December 31, 2005, Blue Square had entered into agreements for investments in fixtures
and equipment in the aggregate amount of approximately NIS 8 million, or $1.7 million.

Dividends

In
addition to the dividends described above under - Sources and Uses of Cash,
the following dividends were paid from 2001 to 2004:

During
2004, Blue Square distributed to its shareholders a dividend of $1.48 per share in an
aggregate amount of approximately NIS 253 million.

In
May 2004, BSIP paid a dividend totaling NIS 400 million, approximately NIS 320 million of
which was distributed to Blue Square, and approximately NIS 80 million of which was
distributed to other shareholders. BSIP financed the distribution in part by bank
financing.

During
2003 Blue Square distributed to its shareholders a dividend of $1.72 per share in
aggregate amount of approximately NIS 295 million.

During
2002, Blue Square distributed to its shareholders a dividend of $0.72 per share in
an aggregate amount of approximately NIS 128 million.

During
2001, Blue Square distributed to its shareholders a dividend of $0.31 per share in an
aggregate amount of approximately NIS 51.9 million.

Blue
Squares Board of Directors has resolved that we will not distribute dividends in any
quarter if the ratio of our financial obligations (as defined by 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 also resolved that Blue Square would not distribute
dividends in any quarter if the ratio of the cost of unencumbered fixed assets as set
forth on our financial statements (following depreciation) to financial obligations (as
defined by Maalot) for a quarter is below 120%.

Short-Term
Credit from Banks

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

|                                      | December 31
|------------------------------------- | -----------
|
|
|
|
|Short- term credit from banks         |            
|                                      |            
|Current maturities of Long-term loans |            
|                                      |            
|                                      |            

54

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Long-Term
Loans from Banks

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

|                              | December 31 | Annual
Interest Rate
%
|----------------------------- | ----------- | ----------------------
|
|
|
|
|In foreign currency -         |             |                       
|Swiss Frank                   |             |                       
|In Israeli currency -         |             |                       
|Linked to the Israeli CPI (2) |             |                       
|Unlinked (3)                  |             |                       
|                              |             |                       
|                              |             |                       
|                              |             |                       
|Less- current maturities      |             |                       
|                              |             |                       
|                              |             |                       
|                              |             |                       

| | (1) Weighted
average rate as of December 31, 2005.
| | --------------------------------------------------

| | (2) The
Company entered into Israels CPIs swap contracts in respect of
          long-term loans. The loss in 2005 amounting to NIS 1,273 thousands was
          recognized in the statements of operations. As of December 31, 2005 the company
          had no outstanding balance related to the above swap contracts.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3)  As
of December 31, 2005, includes NIS 650 million at variable           interest (average
annual rate as of December 31, 2005- 5%, for the major part of           these loans,
based on prime minus 1.12%). The balance of approximately NIS 35           million is at
a fixed annual interest rate of 6.67%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) Including
loan in the amount of NIS 500 million which was taken in connection           with the
real estate reorganization  See note 9b(2) to our consolidated           financial
statements. This loan bears variable interest on the basis of Prime           minus 1.12%
(Prime at December 31, 2005 was 6% per annum), and the principal and           the
interest is repayable in one payment on January 29, 2007. The loan is           secured
by a restricted bank deposit.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Debentures

The
following table summarizes our outstanding debentures in 2004 and 2005:

| |                                   | December 31,
| | --------------------------------- | ------------
|
|
|
|
| | Debentures (Series A)             |             
| |                                   |             
| |                                   |             
| | Convertible debentures (Series B) |             
| |                                   |             

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.
In 2005, convertible debentures (Series B) with a par value of approximately NIS 5.5
million were converted into 167,755 ordinary shares.

55

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| | 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, on August 5 of each of the years 2006, 2008 and 2010, the
holders of the Series A Debentures will be 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.

| | 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 December 31, 2005, each NIS
32.89 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 December 31, 2005. Subsequent to December 31,
2005, we distributed an additional dividend, which further reduced the conversion ratio
such that each NIS 30.836 par value of debentures are convertible to one Ordinary shares
of 1 NIS par value as of June 20, 2006.

Other
terms of the 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 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 June 2006, Maalot confirmed the AA rating on our debentures.

In
addition, our rating from Maalot may be adversely affected by a change in the resolutions
of our Board described under - Dividends above.

For
additional information on charges pertaining to the collateralized long-term loans, see
note 11c to our consolidated financial statements.

56

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# Commitments for Capital
Expenditures

As
of December 31, 2005, we had entered into agreements for investments in fixtures and
equipment in the total amount of NIS 8 million, or $1.7 million. We intend to finance
these investments from cash generated by our operations.

| | C. | Research
and Development, Patents and Licenses.
| | -- | -----------------------------------------------

Not
applicable.

| | D. | Trend
Information.
| | -- | ------------------

We
estimate that growth opportunities for supermarkets in Israel remain as more households
increase purchasing of supermarket goods at supermarkets rather than smaller grocery
stores, mini-markets and open-air markets. We estimate that approximately 34% of the total
retail sales of food, beverages and tobacco in Israel in 2005 was made by the three large
chains and 46% was made by all 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.

The
food retailing industry has been subject to increased competition in recent years. As a
result of the recent merger between Super Sol and ClubMarket, we now face a major
competitor, many of whose stores are characterized by the every day sale of products at
low prices. We estimate that Super Sols market share following the acquisition of
ClubMarket was approximately 39.5% of the bar-coded market in Israel in 2005.

In
addition, as a result of consumers increased focus on the price of products, we and
other major chains have expanded our low-priced store formats and, during 2005, other
major chains have expanded into hard discount store formats. Also, very low-priced private
supermarkets have expanded their presence in selected areas, although the growth in market
share of such private supermarkets slowed during 2005. The increased competition has led
to increased downward pressure on prices. Due to these developments, we converted seven of
our Super Center stores into six Shefa Shuk stores and one Mega store and closed three
underperforming stores in 2005. However, we opened seven new stores to compete in
selective areas in which we did not believe we had sufficient market presence.

During
2005, there was also an increase in sales made by the local neighborhoods and city centers
stores (which are relatively more expensive stores). Such increase may suggest that, at
least for part of the consumers, there has been a change in their buying patterns,
i.e., preferring convenience and geographical proximity to the lower prices of
supermarket stores.

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.

57

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In
2005, we increased our emphasis on increasing our sales, partially in anticipation of an
improving Israeli economy. In 2006, we expect to continue our emphasis on increasing our
sales. This may include increasing our marketing activities.

In
2006, 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.

| | E. | Off-Balance
Sheet Arrangements. None
| | -- | ------------------------------------

| | F. | Tabular
Dislosure of Contractual Obligations. See   Liquidity and           Capital
Resources  Contractual Obligations above.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

58

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|ITEM 6. | DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES
|------- | ------------------------------------------

| | A. | Directors
and Senior Management.
| | -- | --------------------------------

The
following table lists the name, age and position of the directors and executive officers
of Blue Square as of June 15, 2006.

|Name                     | Age | Position                                                        
|------------------------ | --- | ----------------------------------------------------------------
|
|
|
|
|David Wiessman (1)       | 51  | Chairman of the Board of Directors                              
|Yitzhak Bader            | 60  | Director                                                        
|Yaakov Shalom Fisher     | 49  | Director                                                        
|Pinchas Cohen            | 55  | Director                                                        
|Shaul Gliksberg          | 44  | Director                                                        
|Shlomo Even (2)          | 49  | Director                                                        
|Ron Hadassi              | 41  | Director                                                        
|Diana Bogoslavsky        | 47  | Director                                                        
|Elisha Eitani            | 57  | Director                                                        
|David Alphandary (2) (3) | 71  | Director                                                        
|Uzi Baram (1) (2) (3)    | 69  | Director                                                        
|Gil Unger                | 52  | President and Chief Executive Officer                           
|Emanuel Avner            | 45  | Vice President and Chief Financial Officer (until June 30, 2006)
|Dror Moran               | 39  | Vice President and Chief Financial Officer (from July 1, 2006)  
|Uri Falach               | 49  | Vice President for Trade                                        
|Ilan Buchris             | 54  | Vice President for Planning and Maintenance Division            
|Moshe Shatz              | 58  | Head of Human Resources Division                                
|Oren Lahat               | 58  | Head of Real Estate Development Division                        
|Odelia Levanon           | 43  | Head of Information Technology Division                         
|Elli Levinson Sela       | 39  | General Counsel and Corporate Secretary                         
|Shay Lifshitz            | 52  | Head of Trade Headquarters                                      
|Eliezer Gayer            | 49  | "Super Center" Manager                                          
|Yehuda Porat             | 46  | "Shefa Shuk" Manager                                            
|Rafi Masiach             | 47  | "Mega" Manager                                                  
|Dany Magen               | 62  | Supply Chain Manager                                            

(1)
          Member of the Compensation Committee. 
(2) Member of the Audit Committee. 
(3) External directors.

David
Wiessman has served as Chairman of our board of directors from November 15, 2005. Mr.
Wiessman is also the Vice Chairman of the Board of Directors of BSIP. In addition, Mr.
Wiessman is currently the President and Chief Executive Officer of Alon Israel Oil Company
Ltd. and President and Executive Chairman of Dor Alon Energy In Israel (1988) Ltd., Chief
Executive Officer of Bielsol Investments (1987) Ltd., Chairman of the Board of
Bronfman-Alon, Executive Chairman of Alon U.S.A. Energy, Inc. and holds director and/or
officer positions in other companies affiliated with the foregoing Alon entities, both in
Israel and the United States. Mr. Wiessman is a member of the Compensation Committee of
Blue Square.

59

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Yitzhak
Baderhas 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 Dor Alon Energy In Israel (1988)
Ltd., and a director in Bronfman-Alon, 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., Pri-Gat
Ltd., entities under control of Granot, and One Technologies Software (ASD) Ltd.

Yaakov
Shalom Fisher has served as our director from June 2003. Mr. Fisher is currently the
Chairman of the Board of Directors of BSIP, the President of Palace Candles Inc., a
manufacturer and marketer of candles, aluminum disposable and other products in Israel and
in the United States, a director in Bronfman-Alon and BSIP and a director in Blue Square
Furniture Ltd. (the company that holds the Israeli franchise to IKEA in Israel; currently
unrelated to the Company).

Pinchas
Cohenhas served as our director from June 2003. Mr. Cohen is currently Chief Executive
Officer of Africa Israel Investments Ltd., a director in Bronfman-Alon and a director of
subsidiaries and affiliates of Africa Israel Investment Group Ltd., Alon Israel Oil
Company Ltd. and Alon U.S.A. Energy. In addition, Mr. Cohen serves as a director in AL
Navada Holding, Inc., AL Properties and Developments, AL Florida Holding, Inc., Alon
U.S.A. Energy, Inc. (U.S.A) Corp Inc., Alon U.S.A. Inc., Alon U.S.A Capital, Inc., F.
Finding Realities B.V., and Sea (Swim Experts Alliance) B.V.

Shaul
Gliksberghas served as our director since November 2005. He is currently the Chief
Financial Officer of Africa Israel Investments Ltd. He is also Chairman of the Board of
Directors of Peanuts and Cotton Marketing Co., Kol Rega Radio Ltd., TTT Communications
Ltd. and Hassadeh ve Matah Ltd. and various companies affiliated with Dor Alon Group. In
addition, Mr. Gliksberg serves as a director in Alon Israel Oil Company Ltd., Dor Alon
Energy In Israel (1988) Ltd., Alon U.S.A. Inc., Alon U.S.A. Energy Inc., and in numerous
other companies affiliated with the Dor Alon Group and with the Africa Israel group.

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. and
Alon Dor Operating Service Stations Ltd. and other companies. Mr. Even is a member of the
Audit Committee of Blue Square.

Ron
Hadassihas served as our director since June 2003. Mr. Hadassi is currently an employee
of Palace Group, a lecturer for banking and financing at the Interdisciplinary Center in
Herzilya. He is also Chairman of the Board of Directors of Blue Square Furniture Ltd. (the
company that holds the Israeli franchise to IKEA in Israel; currently unrelated to the
Company) and a director in Bronfman-Alon and BSIP, and an external director in
Naaman Porzelon Ltd. and Bet Shemesh Engines Holdings Ltd.

60

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Ms.
          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 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. Currently, Ms. Bogoslavsky is a
          candidate for a Ph.D in economics from the Hebrew University in Jerusalem.

Elisha
Eitanihas served as our director since June 2003. Mr. Eitani is currently Chief Executive
Officer of Hechal  Haner Ltd.

David
Alphandaryhas 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 Supersol Ltd and from 1982 to 1991 as Vice
President to Supersol. 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. and serves on the board of directors of several other companies. Mr. Alphandary holds
a degree in public administration from the Hebrew University in Jerusalem. Mr. Alphandary
is a member of the Audit Committee of Blue Square.

Uzi
Baramhas served as our external director since March 2006. He served as a member of
the 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.

Gil
Unger has served has our Chief Executive Officer and President since March 2004. From
2001 to 2004, he served as the Chief Executive Officer of Blue Square Furniture Ltd. (the
company that holds the Israeli franchise to IKEA in Israel; currently unrelated to the
Company). From 2000 to 2001, Mr. Unger served as Senior Vice President Marketing &
Commerce of Office Depot Israel and between 1998  2000 served as Vice President
Marketing & Commerce of Visa Credit Cards. Previously, for a period of 8 years, he
held the position of Marketing Director of Israels largest chain of drug stores
(Superpharm) and later he served as President of Israels second largest
chain of drug stores (New  Pharm). Mr. Unger holds a B.A. degree in
Economics from Tel Aviv University.

61

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Emanuel
Avner has served as our Vice President and Chief Financial Officer since November 2,
2003. Mr. Avner served from 1999 until October 2003 as Chief Financial Officer of Ericsson
Israel. From 1993 to 1999, he served as Corporate Controller and Deputy CFO of Super Sol
Ltd. Mr. Avner is a CPA (member of the American and Israeli Institute of Certified Public
Accountants) and holds a Masters in Business Administration (1stClass Honors)
and a BA in Economics and Accounting from the Hebrew University of Jerusalem. Mr. Avner
has resigned from his office, effective as of June 30, 2006.

On
May 25 2006, our Board of Directors appointed Mr. Dror Moran as Vice President and Chief
Financial Officer, to begin serving by not later than July 1, 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.

Uri
Falach has served as our Vice President for Trade since December 2003. Mr. Falach
holds an MBA degree in Business Administration. From 1994 until today Mr. Falach served as
manager of the agricultural production and was responsible for all the chain of supply of
the agricultural production to Blue Squares Stores.

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 2000-2004 Mr. Buchris served as Authorities Coordinator at Derech
Eretz Highways (1997) Ltd.

Moshe
Shatz has served as our head of the Human Resources Division since November 2003. Mr.
Shatz served as a manager 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 BA 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. in mathematics and computer science, and also is
a lecturer and a candidate for a doctorate in business school.

62

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Elli
Levinson-Sela, Adv. has served as our General Counsel and Secretary since February
2006. Mr Levinson Sela has more then 13 years of experience in private legal practice of
commercial, corporate and civil law. He holds a LLB degree (with honors) from the Hebrew
University in Jerusalem.

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 BA in Economic and Business
Administration from Bar Ilan University.

Eliezer
Gayer has served as our Super Center Manager since September 2005. From
November 2004 to September 2005, Mr. Gayer served as a 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.

Yehuda
Porathas served as our Shefa Shuk Manager since December 2004. Since
1997, Mr Porat has served as a consultant to the Company. From July 1998 to September
2003, Mr. Porat served as a director of our subsidiary, Shefa Mehadrin Ltd., a company
which operates three Shefa Shuk stores.

Rafi
Masiach has served as our Mega Manager since September 2005. 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. Mashiach 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 Supply Chain Manager 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.

# Termination of Office

Matthew
Bronfmanserved as the Chairman of our Board of Directors and as a director and Vice
Chairman of BSIP Board of Directors until September 2005. Shlomo Zoharserved as
our director until September 2005. Avraham Meronserved as our director until
November 2005. Davidi Marom served as our director until February 2006. Merav
Goldserved as our director until September 2005. David Wainshalserved as our
external director and as a member of our Audit Committee until March 2006. Zeev
Vurembrandserved as our external director and as a member of our Audit Committee
until January 2006. Michael (Miki) Lev served as our Vice President for Operations
until October 2005. Sandrine Montsmaserved as our Vice President for Marketing
until October 2005. Iris Penso, Adv. served as our general counsel and corporate
secretary until February 2006.

63

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# Arrangements for the
Election of Directors

Bronfman
 Alon owns approximately 76.89% of our ordinary shares following the conversion by
other investors of an aggregate of approximately NIS 19.3 million in principal amount of
our 5.9% convertible debentures since their issuance in August 2003. So long as
BronfmanAlon 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, 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.

| | 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 executive officers for services they
rendered Blue Square, for the year ended December 31, 2005. The table also includes
compensation to individuals who cease to serve as directors or executive officer during
the year.

|                             | Salaries, fees, expenses, directors'
fees, commissions and bonuses | Pension, retirement
and similar benefits
|---------------------------- | ------------------------------------------------------------------ | ----------------------------------------
|
|
|
|
|All directors, executive     |                                                                    |                                         
|officers and Acting Chairman |                                                                    |                                         
|as a group                   |                                                                    |                                         

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 are 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. 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.

We
also agreed to pay David Wiessman, our 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 Chairman of the Board. 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 Chairman
of the Board. Our audit committee, board of directors and shareholders meeting approved
this arrangement.

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BSIP
pays Yaakov Shalom Fisher, in his capacity as BSIPs Chairman of the Board of
Directors, a monthly payment of NIS 42,497 plus VAT commencing from November 15, 2005, the
date Mr. Fisher became Chairman of the Board of BSIP. 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. Fisher for attending meetings of the Board of
Directors or any committee of the Board of Directors. Mr. Fisher is also entitled to
reimbursement of actual expenses (upon submission of receipts) incurred by him in
connection with his service as BSIPs Chairman of the Board.

Until
the appointment of David Weissman as our Chairman of the Board, BSIP paid him, in his
capacity as BSIPs Chairman of the Board of Directors, a monthly payment of NIS
42,000 plus VAT commencing from June 24, 2003, the date he became BSIPs Chairman of
the Board. The compensation was linked to changes in Israels CPI since May 2003, and
was updated every three months. Mr. Wiessman was also entitled to reimbursement of actual
expenses incurred by him in connection with his service as Chairman of the Board of BSIP.

Until
September 2005, we paid our former chairman, Matthew Bronfman a monthly payment of NIS
42,000 plus VAT commencing from June 24, 2003, the date Mr. Bronfman became Blue Square
Chairman of the Board. The compensation was linked to changes in Israels CPI since
May 2003 and was updated every three months. Mr. Bronfman was also entitled to
reimbursement of actual expenses incurred by him in connection with his service as the
Chairman of the Board of up to $50,000 per year.

| | 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. The appointment and terms of office
of all our executive officers are determined by the board of directors. 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 that approval of our
board of directors.

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We
and our subsidiaries have no service contract with any of our directors that provide for
benefits upon termination of their employment as directors. For information concerning a
consulting agreement, which was terminated on November 15, 2005, with S. Zohar Consulting
and Management Ltd. (S. Zohar), an entity controlled by Shlomo Zohar, a former director,
please see Item 7. Major Shareholders and Related Party Transactions.

# 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, there
shall not be appointed as a substitute director, any person who is not himself qualified
to be appointed as a director or a person who is already serving as a director or a person
who is already serving as a substitute director for another director. Nevertheless, a
director may be appointed as a substitute director for a committee of the board of
directors if (s)he is not already serving as a member of the committee. Under the Israeli
Companies Law, there shall not be appointed a substitute director for 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.

# 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
have been offered to the public in or outside of Israel (Public Company) are required to
appoint 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 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;
|- | ----------------------------------------------------------------------

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| | 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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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
a recent 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 recently
enacted 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.

Under
the amendment each Israeli public company was required to determine, no later than April
19, 2006, 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. On March 21, 2006, our Board determined that
two directors with accounting and financial expertise is appropriate for the
Company. Our board 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 us.

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The
initial term of an external director is three years and may be extended for an additional
three years. 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 its audit committee is
required to include all of the external directors.

David
Alphandary and Uzi Baram currently serve as our external directors.

New
York Stock Exchange Requirements

See
  Audit Committees  New York Stock Exchange Requirements for a
description of the independence requirements for audit committee members under applicable
NYSE rules.

# Audit Committees

Israeli
Companies Law Requirements

Under
the Israeli Companies Law, the board of directors of 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 us 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 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 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.

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The
independence requirements 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 of an issuer that is not an investment company 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.

As
of June 15, 2006, David Alphandary, Uzi Baram and Shlomo Even served as members of our
audit committee.

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.

# 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, an office holder or an interested party, nor
may the internal auditor be our independent accountant or its representative. We comply
with this requirement. Effective January 1, 2005, Ronit Zilberfarb was our internal
auditor.

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# 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;
|- | --------------------------------------------------------------------------------------------------------------------------------

| | 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.
|- | -----------------------------------------------------------------------------------------------

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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. An office holder who has a personal interest in a matter,
which is considered at a meeting of the board of directors or the audit committee, may not
be present at this meeting or vote on this matter. If most 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.

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 who is an office holder, 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 and 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.

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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.

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, 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

Under
the Israeli Companies Law, an Israeli company may not exempt an office holder from
liability with respect to a breach of his duty of loyalty, but may exempt in advance an
office holder from his liability to the company, in whole or in part, with respect to a
breach of his duty of care. However, a company may not exempt in advance a director from
his liability to the company with respect to a breach of duty of care in connection with a
distribution made by the company.

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:

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| | 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.
|- | -----------------------------------------------------------------------------------------------

Exemption
and Indemnification of Office Holders

Blue
Squares Articles of Association provides that Blue Square may undertake to indemnify
an Office Holder for future obligations or expenses imposed on him as a result of an act
done in his capacity as an Office Holder, as specified below:

| | (i)
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 concerning an act performed in his capacity as an office holder; and
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii)
reasonable litigation expenses, including counsel fees, incurred by an office holder or a
former office holder or which he is ordered to pay by a court, in proceedings Blue Square
institutes against him or instituted on Blue Square behalf or by another person, or in a
criminal charge from which he was acquitted, or a criminal charge in which he was
convicted for a criminal offense that does not require proof of intent, in each case
relating to an act performed in his capacity as an office holder.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Israeli Companies Law provides that a company may exempt an office holder prospectively
from liability, in whole or in part, for damage resulting from a breach of his duty of
care towards the company, if its Articles of Association so provide. Blue Squares
Articles of Association so provides.

In
February 2001, our shareholders approved amendments to our Articles of Association
enabling us to provide our office holders with prospective indemnification in relation to
events that will occur or have occurred since February 1, 2000. The aggregate amount of
the indemnification may not exceed 25% of our shareholders equity as stated in our
consolidated financial statements for the year ended December 31, 2000 for all persons and
all events to be indemnified.

Recent
Changes to Israeli Companies Law. Recent changes to the Israeli Companies Law now
permit us to indemnify an office holder against 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.

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In
addition, prior to the recent changes in the Israeli Companies Law, the shareholders of a
company were permitted to include only the following provisions in its articles of
association (and our articles of association currently so provide):

| | a
provision authorizing the company to grant in advance an undertaking to indemnify an
office holder, provided that the undertaking is limited to specified classes of events
which the board of directors deem foreseeable at the time of grant and is limited to an
amount determined by the board of directors to be reasonable under the circumstances; or
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
provision authorizing the company to retroactively indemnify an office holder.
|- | --------------------------------------------------------------------------------

The
recent changes now permit a company to include or amend its articles of association to
include any or all of the following provisions:

| | 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), as described in clause (i) under -Exemption and
Indemnification of Office Holders above, so long as such indemnification is limited
to types of events which, in the Boards 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 deems reasonable under the circumstances. Such
undertaking must specify the events that in the Boards 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 deemed reasonable at the time;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
provision to undertake to indemnify for future events as set forth with respect to
litigation expenses described in clause (ii) under - Exemption and Indemnification
of Office Holders and in the first paragraph under - Exemption and
Indemnification of Office Holders  Recent Changes to Israeli Companies Law;
or
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
provision authorizing the company to retroactively indemnify an Office Holder.
|- | --------------------------------------------------------------------------------

Limitations
on Insurance and Indemnification

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

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

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| | 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:

| | 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;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | 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 officeholder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.

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;
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|2. | A
violation 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 its subsidiaries). 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 1, 2005, and ending on October
31, 2006, for the maximum coverage of US$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.

In
the event that the Insurance Policy covers our directors and officers and those of BSIP
and their respective subsidiaries, the payment of the Annual Premium will be divided
between Blue Square and BSIP in such a manner as to be in the same proportion as the
equity of each of them relates to the sum of our equity and that of BSIP and their
respective subsidiaries, as presented in their respective current annual audited
consolidated Financial Statements.

# 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 Shlomo Even, 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 See Item 6. Directors, Senior Management and Employees  C.
Board Practices Audit Committees.

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| | D. | Employees.
| | -- | ----------

As
of December 31, 2005, we employed 6,330 employees, counting multiple employees sharing a
single position as a single employee, including 3,135 temporary employees. 690 of our
employees were employed in central management and administration and in our logistics
center and 5,640 in our stores.

As
of December 31, 2004, we employed 6,590 employees, counting multiple employees sharing a
single position as a single employee, including 3,400 temporary employees. 660 of our
employees were employed in central management and administration and in our logistics
center and 5,930 in our stores.

As
of December 31, 2003, we employed 6,650 employees, counting multiple employees sharing a
single position as a single employee. 645 of our employees were employed in central
management and administration and in our logistics center and 6,005 in our stores.

On
November 5, 2003, pursuant to our agreement with the Histadrut (General Federation of
Labor in Israel) (Histadrut), we announced the dismissal of approximately 100 employees
from our headquarter staff and another 150 store employees. In addition, during 2004, we
dismissed approximately 30 people from the Planning and Maintenance Division. 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, 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
respect of grants to our employees, we entered into a collective bargaining arrangementwith the Histadrut and the National Committee of the Co-Op Blue Square Employees in
August 2003. Under that agreement, we agreed (i) to grant to our permanent employees a
good will grant of NIS 37.5 million in the aggregate in two installments, the
first of which in August 2003 and the second in April 2004; (ii) to grant NIS 2 million to
employees allocated in the manner determined by our chairman and the chairman of an
employees committee; (iii) to grant an additional NIS 1 million to our temporary
employees; (iv) 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
(v) 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.

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As
a result of the above mentioned benefits, we recorded a one-time expense of NIS 63.9
million in the second quarter of 2003 (before income taxes and minority interest).

In
October 2003, we entered into a collective bargaining arrangementwith the
Histadrut and the National Committee of Blue Square-Israel. Under this agreement, the
parties agreed to certain employee rights in the context of the implementation of our
efficiency plan, including the severance package associated with any termination of
employees. The initial term of the agreement expired on December 31, 2004 and was not
renewed.

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.

Recently,
we have reached an understanding with the employees representative regarding the
increase of the contribution made by the Company on account of employee savings plans from
1.5% of employee salaries to 3.0% effective January 1, 2006. A special written collective
bargaining arrangement incorporating such understanding has not yet been signed.

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, contributions to a pension
fund, insurance for work-related accidents, procedures for dismissing employees,
determination of severance pay and other conditions of employment.

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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, 2006, other than indirect ownership through Bronfman  Alon, none of our
directors or officers owned more than 1% of our outstanding equity securities.

|ITEM 7. | MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|------- | -------------------------------------------------

| | A. | Major
Shareholders.
| | -- | -------------------

The
following table sets forth certain information regarding the beneficial ownership of our
ordinary shares as of June 15, 2006, 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 Beneficially
Owned | Percentage of
Outstanding Ordinary
Shares (1)
|------------------- | -------------------------------------------- | ---------------------------------------------
|
|
|
|
|Bronfman - Alon (2) |                                              |                                              

---

|(1) | The
percentage of outstanding ordinary shares is based on 38,950,091 ordinary
               shares outstanding as ofJune 15, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(2) | BronfmanAlon
has granted an option to an Israeli bank until June 23, 2008,                to acquire
from BronfmanAlon a number of shares equal to three (3%)                percent of
Blue Squares issued and outstanding shares at the time of                exercise.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As
of June 20, 2006, Blue Square had approximately 29 shareholders of record with a
United States address. As of June 20, 2006, these United States record holders held
approximately 3,001,488 ordinary shares in the form of ADSs, representing approximately 7.7% of our then outstanding share capital.

BronfmanAlon
acquired a 78.1% interest in Blue Square from the Co-Op in June 2003. Bronfman-Alons
percentage interest in Blue Square has been reduced to 76.89% due to the conversion by
other investors of an aggregate of approximately NIS 19.3 million in principal amount of
our 5.9% convertible debentures since their issuance in August 2003.

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To
the Companys best knowledge, BronfmanAlon is a wholly owned subsidiary of
Nissan Alon Retail Holdings Ltd., which is a wholly owned subsidiary of the Nissan Dor
Chains Ltd. (Grandparent Company). Dor Food Chains Holdings Ltd. (Dor
Food) holds 73.5% of the equity interest of the Grandparent Company, and the other
26.5% of the equity interest is held by M.B.I.S.F. Holdings Ltd. (M.S.). Dor
Food is 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.

To
the Companys best knowledge, M.S. is a wholly owned subsidiary of Bronfman-Fisher
Investments Ltd. (Bronfman-Fisher), Matthew Bronfman owns approximately 49.8%
of the equity of Bronfman-Fisher and Yaakov Shalom Fisher owns the remaining 50.2% of the
equity.

| | B. | Related
Party Transactions.
| | -- | ---------------------------

Procurement
Agreement with Dor Alon Stations

Dor
Alon Operating Service Station Ltd., a subsidiary of Dor-Alon Gas Station Operation Ltd (a
wholly owned subsidiary of Dor-Alon Energy In Israel (1988) Ltd which is controlled by
Alon Oil Energy Company Ltd) (hereinafter: Dor-Alon Stations), operates
convenience stores in fuel service stations 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.

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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.

Management
Agreement with Co-Op

The
Co-Op, our former controlling shareholder, provided us with management and other services.
The service agreement became effective in April 1996 and expired in June 2003. For the
period starting January 2003 until expiration in June 2003, we paid the Co-Op $ 250,000.

Transactions
with Dor Alon in Connection with Establishment of a New 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 for the establishment of a joint loyalty plan for the benefit of
          our customers and Dor Alons customers, formed as a partnership to be held
          75% by us and 25% by Dor Alon;

(ii)
          an agreement to acquire, together with Dor Alon, 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 closing of this acquisition is
subject to the           satisfaction of certain conditions; and

(iii)
          an agreement among us and Dor Alon, on one hand, and Diners Club Israel Ltd.
          (Diners Israel), on the other hand, pursuant to which the Loyalty
          Plan will offer to its members a credit card issued by Diners Israel.

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See
Item 4. Information on The Company  B. Business Overview 
Marketing.

# Arrangements between
Blue Square and various subsidiaries

On
October 11, 2005, we entered into a general services framework and expenses allotment
agreement with BSIP and Hyper Hyper (the Agreement). The Agreement is for an
initial term of five years and will 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 are 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 is
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.

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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.

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 which depends on the insurance involved.

Leasing
of Property by the Company. For real property that the Company currently leases and/or
may lease to BSIP and/or to Hyper Hyper,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 for 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 the Company, which
amount is to be linked to changes in Israels consumer price index since the date of
such investment;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
annual rent for property not used for stores will be 9% of the amount invested by the
Company, which amount is to be linked to changes in Israels consumer price index
since the date of such investment; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Rent
payments will be charged on an annual basis.
| | - | -------------------------------------------------

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 for 10 years from
the date such new lease agreement is executed for a particular property, and (iii) the
aggregate properties that the Company leases to BSIP and/or Hyper Hyper may not exceed
80,000 square meters (i.e., 20% more than the area of the aggregate properties the
Company leased to BSIP and/or Hyper Hyper at the time of the Agreement).

The
real property that the Company currently leases to BSIP and/or to Hyper Hyper has been
transferred, and the related lease agreements assigned, to BSRE, the Companys wholly
owned subsidiary. See Item 4. Information on the Company  B. Business Overview
 Real Estate.

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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.
| | - | -------------------------------------------------

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 (i.e., 20% more than the area of the aggregate properties BSIP and/or Hyper
Hyper leased to the Company at the time of the Agreement).

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:

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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. Approximately 3,092 employees are working for Hyper Hyper under that
arrangement as of December 31, 2005. 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 74 million in 2005.

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

Blue
Square and Hyper Hyper have an agreement according to which Blue Square identifies
facilities suitable for the Hyper stores. In the event Hyper Hyper elects not to use,
acquire or lease such facilities, Blue Square may elect to do so. Hyper Hyper has rights
to acquire or lease facilities of approximately 1,500 square meters or more with
approximately 80 parking spaces, and Blue Square has 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.

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Inter-Company
Accounts

We,
BSIP and Hyper Hyper agreed to maintain inter-company accounts for day-to-day operations
which bore 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 5.2% in 2005, 5.5% in 2004 and 8.5% in 2003.

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.

Consulting
Agreement with Shlomo Zohar

Until 2005,
we were a party to a consulting agreement with S. Zohar Consulting and Management Ltd. (S.
Zohar), an entity controlled by Shlomo Zohar, one of our former directors, as an
independent contractor to provide us, our subsidiaries and/or our affiliated companies
accounting consulting services in various areas, including accounting consulting to our
management group, tax planning and advice, due diligence, accounting analyses, internal
accounting control over our activities and transactions, accounting implications for
recovery plans, accounting advice with respect to the issuance of debentures and the like.
S. Zohar provided the services through Shlomo Zohar, CPA. The services provided under the
consulting agreement through Mr. Shlomo Zohar were unrelated to the services provided by
Mr. Shlomo Zohar to us in his capacity as a director. In consideration for the services,
we paid S. Zohar the NIS equivalent of US $20,000 per month plus VAT. This agreement was
terminated on November 15, 2005.

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 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.

We
are a party to a supply agreement with Palace Candles Inc. (Palace), a
manufacturer and marketer of candles, aluminum disposable and other products, which is
controlled by Yaakov Shalom Fisher. Mr. Fisher is a director in Bronfman-Alon, Blue Square
and the Chairman of the Board of directors of BSIP and owns approximately 50.2% of the
equity in M.B.I.S.F. Holdings Ltd., which indirectly holds 26.5% of the equity interest of
Bronfman-Alon, our controlling shareholder. Pursuant to the agreement, we paid to Palace
approximately NIS 44 million in 2005 for products acquired.

87

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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.

| | C. | Interests
of Experts and Counsel.
| | -- | ---------------------------------

Not
applicable.

|ITEM 8. | FINANCIAL
INFORMATION
|------- | ---------------------

| | A. | Consolidated
Statements and Other Financial Information.
| | -- | --------------------------------------------------------

The
financial statements required by this item are found at the end of this annual report,
beginning on page F-1.

# Legal Proceedings

We
may be subject to class actions filed against Israeli supermarkets under the Israeli
Consumer Protection Act of 1981.

In
June 2003, a petition to certify a class action suit in the aggregate amount of NIS 25
million was filed against us in the Tel Aviv District Court. The plaintiff claimed damages
allegedly incurred in respect of the unlawful rounding of amounts due from customers for
products sold by weight in the stores of the companies. The petition to certify a class
action suit has been rejected by the District Court. Following the dismissal of the claim
by the district court, the plaintiff has appealed to the Supreme Court. We believe, based
on the opinion of legal counsel, that it is unlikely that the appeal will be accepted, and
accordingly no provision with respect to the above suit has been recorded in the financial
statements.

We
may be subject to a class action in connection with the Law for Deposits on Beverage
Containers, 1999.

In
November 2001 a claim was filed against Blue Square, the Company for Drink Containers
Collection Corporation Ltd., and other supermarket chains in connection with fulfillment
by these defendants of provisions of the Law for Deposits on Beverage Containers, 1999
(which became effective on October 1, 2001). The plaintiffs have requested to certify the
claim as a class action in the amount of approximately NIS 250 million. On January 13,
2003, the Tel Aviv District Court dismissed the motion to certify the said claim as a
class action. The plaintiffs have appealed to the Supreme Court. We believe, based on the
opinion of legal counsel, that the likelihood of the appeal being accepted is minimal and
accordingly no provision has been included in the financial statements in respect thereof.

88

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We
may be required to pay amounts in connection with tax assessments.

Our
tax assessments for the years 1999-2001, are final except for one issue relating to
certain interest expenses that were deducted by the company in these years. The income tax
authority and the Company agreed that the discussion on this issue would be postponed
until a similar case, involving another company will be finalized in the Supreme Court.
The income tax authority and the Company agreed that, in the meantime, the Company would
submit a formal notice of appeal on that issue, and the Company so submitted. In our
opinion, we will not be required to pay material amounts, if any, in connection with these
assessments, in excess of the accruals included in the financial statements.

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 August 2005, the Company contested these assessments. In
November 2005, several senior employees were interrogated under warning, with respect to
these benefits. As of the date of this annual report, the Company is holding discussions
with the tax authorities through its advisors. 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.

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. We and the other
major chains held a few meetings with the Commissioner with respect to his final position
document and the contents of the proposed consent decree; however, we did not reach to an
understanding and the negotiations have ceased. Please see Item 4. Information on
Blue Square  B. Business Overview  Government Regulation.

89

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

In
2002, the director 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 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.

# 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 financial obligations (as
defined by Maalot) to EBITDA for any quarter exceeds 3.5 until June 30, 2006 or exceeds
3.0 thereafter. The Board also decided that Blue Square would not distribute dividends in
any quarter if the ratio of the cost unencumbered fixed assets as set forth on our
financial statements (following depreciation) to financial obligations (as defined by
Maalot) for any quarter is below 120%. These Board resolutions are not the dividend policy
of Blue Square and they may be amended at any time by our Board of Directors.

# Independent Accountants

On
February 2, 2006, Blue Square shareholders approved the reappointment of Kesselman &
Kesselman, certified public accountants in Israel and a member of PricewaterhouseCoopers
International Limited, as our auditors for the year ending December 31, 2006. Kesselman
& Kesselman has no relationship with us or with any affiliate of us, except as
auditors.

| | B. | Significant
Changes.
| | -- | --------------------

Except
as otherwise disclosed in this annual report, no significant change has occurred since
December 31, 2005.

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|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 | Low
|---- | ---- | ---
|
|
|
|
|2001 |      |    
|2002 |      |    
|2003 |      |    
|2004 |      |    
|2005 |      |    

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 | Low
|-------------- | ---- | ---
|
|
|
|
|2004           |      |    
|First quarter  |      |    
|Second quarter |      |    
|Third quarter  |      |    
|Fourth quarter |      |    
|               |      |    
|2005           |      |    
|First quarter  |      |    
|Second quarter |      |    
|Third quarter  |      |    
|Fourth quarter |      |    
|               |      |    
|2006           |      |    
|First quarter  |      |    

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.

91

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|2005     | High | Low
|-------- | ---- | ---
|
|
|
|
|December |      |    
|         |      |    
|
|January  |      |    
|February |      |    
|March    |      |    
|April    |      |    
|May      |      |    

For
additional information on Blue Squares ADSs, see Item 10. Additional
Information  B. Memorandum and Articles of Association- Description of Securities-
American Depositary Receipts.

# Ordinary Shares

The
following table sets forth the annual high and low closing prices for Blue Squares
ordinary shares for the years 2001, 2002, 2003, 2004 and 2005 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 | Low
|---- | ---- | ---
|
|
|
|
|2001 |      |    
|2002 |      |    
|2003 |      |    
|2004 |      |    
|2005 |      |    

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.

|2004           | High | Low
|-------------- | ---- | ---
|
|
|
|
|First Quarter  |      |    
|Second quarter |      |    
|Third quarter  |      |    
|Fourth quarter |      |    

|2005           | High | Low
|-------------- | ---- | ---
|
|
|
|
|First Quarter  |      |    
|Second Quarter |      |    
|Third Quarter  |      |    
|Fourth Quarter |      |    

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|2006          | High | Low
|------------- | ---- | ---
|
|
|
|
|First Quarter |      |    

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.

|2005     | High | Low
|-------- | ---- | ---
|
|
|
|
|December |      |    
|         |      |    
|
|January  |      |    
|February |      |    
|March    |      |    
|April    |      |    
|May      |      |    

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.

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.

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|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.

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.

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# Board of Directors

Under
Blue Squares Articles of Association the board of directors shall not, without the
affirmative vote of at least seventy five percent (75%) of the members of the board of
directors who participate and vote at a meeting of the board of directors, resolve to do
any of the following: a) approve any material transaction involving Blue Square group
which requires the Blue Square group to invest in equity a sum exceeding 20 Million US
Dollars; b) approve the entering into new fields of business by the Blue Square Group; c)
approve transactions between Blue Square group and Interested Parties; d) approve
amendments to the Articles of Association of the Company; or e) approve a merger between
the Company and Blue Square Investments & Properties Ltd. (BSIP); or an
acquisition offer regarding BSIP shares held by the public; or reorganizational structural
changes of the Company or BSIP.

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, except as described in
the previous paragraph. 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.

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:

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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, an office holder who has a personal interest in a
matter, which is considered at a meeting of the board of directors or the audit committee,
may not be present 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.

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.

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The
ordinary shares do not have preemptive rights, preferred right 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 recently
          amended regulation 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.

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, Bronfman-Alon has
the power to elect all of our directors other than our two external directors. See Item 3.
Key InformationD. Risk Factors Bronfman-Alon is able to control the
outcome of matters requiring shareholder approval.

Dividend
and Liquidation Rights. Our profit, in respect of which 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.

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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 and is obligated to do so upon a written request
in accordance with the Israeli Companies Law. 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.

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.
| | -- | -------------------

For
a summary of material contracts, see Item 4. Information on Blue Square
Property, Plants and Equipment, 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
and Indemnification, Item 6. Directors, Senior Management and Employees 
D. Employees, Item 7. Major Shareholders and Related Party Transactions 
B. Related Party Transactions, Item 10. Additional Information  B.
Memorandum and Articles of Association  Description of Securities  American
Depositary Receipts and our consolidated financial statements and notes included
elsewhere in this annual report.

98

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| | 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 (Shares).

This
discussion does not purport to be a complete analysis of all potential tax consequences of
owning ordinary shares or ADSs. 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.

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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 thatunder 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.

# Corporate Tax Structure

General

In
accordance with the 2006 Tax Reform, the 34% corporate tax rate in 2005 is scheduled to be
reduced to 31% in 2006, 29% in 2007, to 27% in 2008, to 26% in 2009 and to 25% in for 2010
and thereafter.

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

100

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Corporate
Taxation Under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985, generally referred to as the Inflationary
Adjustments Law. The Inflationary Adjustments Law was designed to neutralize the erosion
of capital investments in businesses and to prevent tax benefits resulting from the
deduction of inflationary financial expenses. The law applies a supplementary set of
inflationary adjustments to the normal taxable profit computed according to regular
historic cost principles. Generally, the Inflationary Adjustments Law provides tax
deductions and adjustments to depreciation deductions and tax loss carry forwards to
mitigate the effects resulting from an inflationary economy. The Inflationary Adjustments
Law is highly complex. Its principal features can be described as follows:

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

| | Where
a companys depreciated cost of fixed assets exceeds its equity, then the excess
multiplied by the applicable annual rate of inflation is added to taxable income. Note
that the cost of fixed assets is also calculated under the Inflationary Adjustments Law.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subject
to specified limitations, depreciation deductions on fixed assets and losses carried
forward are adjusted for inflation based on the increase in the CPI.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
the Inflationary Adjustments Law, results for tax purposes are measured in real terms in
accordance with the changes in the CPI. Since a portion of our expenses accrues in
dollars, the discrepancy between the change in the CPI and the change in the exchange rate
of the NIS to the dollar, each year and cumulatively, may result in a significant
difference between taxable income and the income denominated in NIS reflected in our
financial statements.

Taxation
of the Company Shareholders

Dividends

| |  | Israeli
resident  The distribution of dividend income to Israeli residents who
purchased our Shares will generally be subject to income tax at a rate of 20% (in 2006)
for individuals (25% if the dividends receipient is a significant shareholder (interalia, more than 10% of our outstanding voting rights during the 12 months
prior to a dividend distribution)) and will be exempt from income tax for corporations.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Non
Israeli resident  non Israeli residents (both individual and corporation) are
generally subject to Israeli income tax on the receipt of dividends paid on the ordinary
shares at the rate of 20% (25% if the dividends receipient is a significantshareholder (see
aforementioned)), which tax will be withheld at source. Under the U.S.-Israel Tax Treaty,
the maximum tax on dividends paid to a holder of the ordinary shares who is a U.S.
resident is 25%.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

101

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# Capital Gains Tax

General

Israeli
law imposes a capital gains tax on the sale of capital assets by an Israeli resident and
on the sale of capital assets located in Israel or the sale of direct or indirect rights
to assets located in Israel, including on the sale of the Shares by some of our
shareholders (see discussion below). The Israeli Tax Ordinance distinguishes between
Real Gain and Inflationary Surplus. Real Gain is the excess of the
total capital gain over Inflationary Surplus computed on the basis of the increase in the
Israeli CPI between the date of purchase and the date of sale.

Inflationary
Surplus, that accrued after December 31, 1993, is exempt from any tax.

Capital
Gains Taxes Applicable to Israeli Shareholders

Real
Gains derived from the disposal after January 1, 2003 of an asset purchased prior to this
date will be subject to capital gains tax at a blended rate. The regular corporate tax
rate of 31% (in 2006) and a marginal tax rate of up to 49% (in 2006) for individuals will
be applied to 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 a 25% rate for corporations (31%, in 2006, if the
corporation are subject to the Inflationary Adjustments Law) and 20% for individuals (25%
if the shareholder is a significant shareholder (see aforementioned),
or if the shareholder claims a deduction of financing expenses).

The
Real Gain accrued at the sale of an asset purchased on or after January 1, 2003 will be
tax as follows:

| |  | 20%
rate for individuals (25% if the shareholder is a "significant shareholder"
(see aforementioned), or if the shareholder claims a deduction of
financing expenses); and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 25%
for corporations (which are not subject to the Inflationary Adjustments Law).
| | - | ---------------------------------------------------------------------------------

102

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Capital
Gains Taxes Applicable to Non-Israeli Shareholders

Capital
gains from the sale of our ordinary shares by non-Israeli shareholders are exempt from
Israeli taxation. In addition, the U.S.-Israel Tax Treaty exempts U.S. residents who hold
an interest of less than 10% in an Israeli company, and who held an interest of less than
10% during the 12 months prior to a sale of their shares, from Israeli capital gains tax
in connection with such sale.

Generally,
within 30 days of a transaction a detailed return, including a computation of the tax due,
should be submitted to the Israeli Tax Authorities, and a tax advance amounting to the tax
liability arising from the capital gain is payable. At the sale of traded securities, the
aforementioned detailed return may not be submitted and the tax advance should not be paid
if all tax due was withheld at the source according to applicable provisions of the
Israeli Tax Ordinance and regulations promulgated thereunder.

Capital
gains are also reportable on annual income tax returns.

Taxation
of investors engaged in a business of trading securities

Individual
and corporate shareholders dealing in securities in Israel are taxed at the tax rates
applicable to business income (31% for a corporation in 2006, and a marginal tax rate of
up to 49% for individuals).

Withholding
at source from capital gains upon the sale of traded securities

As
of the commencement of the Tax Reform, Israeli stockbrokers are obliged to withhold tax
upon the sale of traded securities. The applicable withholding tax rate is, generally, 20%
from the real gain.

United
States Federal Income Tax Considerations

Subject
to the limitations described in the next paragraph, the following discussion describes the
material United States federal income tax consequences to a holder of Blue Squares
ordinary shares, referred to for purposes of this discussion as a U.S. holder,
that is:

| | a
citizen or resident of the United States;
|- | -------------------------------------------

| | a
 corporation  created or organized in the United  States or under the laws of the United
States          or of any State;
|- | ---------------------------------------------------------------------------------------------------------------------------

| | an
estate,  the income of which is includible in gross income for United  States  federal
 income          tax purposes regardless of its source; or
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | a
trust,  if a court within the United States is able to exercise  primary  supervision
 over the          administration  of the trust and one or more U.S.  persons  have the
 authority  to  control  all          substantial decisions of the trust.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.

103

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---



This
summary is for general information purposes only. It does not purport to be a
comprehensive description of all of the tax considerations that may be relevant to each
persons decision to purchase ordinary shares.

This
discussion 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 discussion does not address all aspects of
United States federal income taxation that may be relevant to any particular shareholder
based on such shareholders individual circumstances. In particular, this discussion
considers only U.S. holders that will own ordinary shares as capital assets and does not
address the potential application of the alternative minimum tax or United States federal
income tax consequences to U.S. holders that are subject to special treatment, including
U.S. holders that:

| | are
broker-dealers or insurance companies;
|- | ------------------------------------------

| | have
elected mark-to-marketing accounting;
|- | ------------------------------------------

| | are
tax-exempt organizations;
|- | -----------------------------

| | are
financial institutions or "financial services entities";
|- | ------------------------------------------------------------

| | hold
ADSs or ordinary  shares as part of a straddle,  "hedge" or  "conversion  transaction"
 with          other investments;
|- | -----------------------------------------------------------------------------------------------------------------------------

| | own
directly, indirectly or by attribution at least 10% of Blue Squares shares
representing at least 10% of Blue Squares shareholders voting power;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | have
a functional currency that is not the dollar.
|- | --------------------------------------------------

In
addition, this discussion does not address any aspect of state, local or non-United States
tax laws.

Additionally,
the discussion does not consider the tax treatment of persons who hold ADSs or ordinary
shares through a partnership or other pass-through entity or the possible application of
United States federal gift or estate tax. Material aspects of United States federal income
tax relevant to a holder other than a U.S. holder are also discussed below.

Each
holder of ADSs or ordinary shares is advised to consult such persons own tax advisor
with respect to the specific tax consequences to such person of purchasing, holding or
disposing of Blue Squares ADSs or ordinary shares.

104

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Taxation
of Dividends Paid on Ordinary Shares

A
U.S. holder will be required to include in gross income as ordinary income the amount of
any distribution paid on ordinary shares, including any Israeli taxes withheld from the
amount paid, on the date the distribution is received to the extent the distribution is
paid out of our current or accumulated earnings and profits as determined for United
States federal income tax purposes. Distributions received by a U.S. holder who is an
individual from a qualified foreign corporation are taxed at the top rate of
15%. The individual must hold the ordinary shares for more than 60 days during the 120 day
period beginning 60 days before the ex-dividend date in order for the distribution to be
eligible for this rate of tax. A qualified foreign corporation is (1) a
foreign corporation with shares that are readily tradable on an established securities
market in the United States including ordinary shares and ADSs or (2) a foreign
corporation that is eligible for benefits under a comprehensive income tax treaty with the
United States. A qualified foreign corporation does not include any foreign
corporation which for the taxable year of the corporation in which the dividend was paid
or the preceding taxable year is a passive foreign investment company. Distributions made
by a foreign corporation that is not a qualified foreign corporation are taxed
at a maximum rate of 35%. Distributions in excess of these earnings and profits will first
be applied against and will reduce the U.S. holders tax basis in the ordinary shares
and, to the extent the distribution is in excess of such tax basis, will be treated as
gain from the sale or exchange of the ordinary shares.

U.S.
          holders will have the option of claiming the amount of any Israeli income taxes
          withheld at source either as a deduction from gross income or as a
          dollar-for-dollar credit against their United States federal income tax
          liability. Individuals who do not claim itemized deductions, but instead
utilize           the standard deduction, may not claim a deduction for the amount of the
Israeli           income taxes withheld, but such amount may be claimed as a credit
against the           individuals United States federal income tax liability. The
amount of           foreign income taxes which may be claimed as a credit in any year is
subject to           complex limitations and restrictions, which must generally be
determined on an           individual basis by each shareholder. The limitations set out
in the Code           include, among others, rules which limit foreign tax credits
allowable with           respect to specific categories of income to the United States
federal income           taxes otherwise payable with respect to each specific category
of income.           Distributions of current or accumulated earnings and profits will be
foreign           source passive income for United States foreign tax credit purposes and
will not           qualify for the dividends received deduction available to
corporations. The           total amount of allowable foreign tax credits in any year
cannot exceed regular           U.S. tax liability for the year attributable to foreign
source taxable income.           However, a U.S. holder who is an individual may elect
not to be subject to the           foreign tax credit limitation rules if all of that
U.S. holders foreign           source income is qualified passive income and his or
her creditable foreign           taxes do not exceed $300, or $600 for joint returns, in
a taxable year.           Qualified passive income includes dividends and other amounts,
but only to the           extent the U.S. holder receives a Form 1099 or similar payee
statement with           respect to that qualified passive income. A U.S. holder will be
denied a foreign           tax credit with respect to Israeli income tax withheld from
dividends received           on the ordinary shares to the extent such U.S. holder has
not held the ordinary           shares for at least 16 days of the 30-day period
beginning on the date which is           15 days before the ex-dividend date or to the
extent such U.S. holder is under           an obligation to make related payments with
respect to substantially similar or           related property. Any days during which a
U.S. holder has substantially           diminished its risk of loss on the ordinary
shares are not counted toward           meeting the 16-day holding period required by the
statute.

105

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Taxation
of the Disposition of Ordinary Shares

Upon
the sale, exchange or other disposition of ordinary shares, a U.S. holder will recognize
capital gain or loss in an amount equal to the difference between such U.S. holders
basis in the ordinary shares, which is usually the cost of such shares, and the amount
realized on the disposition. Capital gain from the sale, exchange or other disposition of
ordinary shares is eligible for a maximum 15% rate of taxation for individuals. Capital
gain from the sale, exchange or other disposition of ordinary shares is taxed as ordinary
income at a maximum rate of 35% for a corporate shareholder. Gains and losses recognized
by a U.S. holder on a sale, exchange or other disposition of ordinary shares will be
treated as United States source income or loss for United States foreign tax credit
purposes. The deductibility of a capital loss recognized on the sale, exchange or other
disposition of ordinary shares is subject to limitations.

Tax
Consequences if Blue Square is a Passive Foreign Investment Company

Blue
Square will be a passive foreign investment company, or PFIC, if 75% or more of its gross
income in a taxable year, including the pro rata share of the gross income of any company,
U.S. or foreign, in which Blue Square is considered to own 25% or more of the shares by
value, is passive income. Alternatively, Blue Square will be considered to be a PFIC if at
least 50% of its assets in a taxable year, averaged over the year and ordinarily
determined based on fair market value and including the pro rata share of the assets of
any company in which Blue Square is considered to own 25% or more of the shares by value,
are held for the production of, or produce, passive income. Passive income includes
amounts derived by reason of the temporary investment of funds raised in our public
offerings. If Blue Square were a PFIC, and a U.S. holder did not make an election to treat
us as a qualified electing fund (as described below):

| | excess
 distributions  by Blue Square to a U.S.  holder would be taxed in a special way.
 "Excess          distributions"  are amounts  received by a U.S.  holder with respect to
Blue Square's  securities          in any taxable year that exceed 125% of the average
 distributions  received by that U.S.  holder          from Blue  Square  in the  shorter
 of either  the  three  previous  years or that U.S.  holder's          holding period
for ordinary shares before the present  taxable year.  Excess  distributions  must
         be allocated  ratably to each day that a U.S.  holder has held Blue Square's
 securities.  A U.S.          holder must include  amounts  allocated to the current
 taxable year,  and any prior taxable year          in which Blue  Square was not a PFIC,
 in its gross  income as ordinary  income for that year.  A          U.S.  holder must
pay tax on amounts  allocated  to each prior  taxable year in which Blue Square
         was PFIC at the highest  rate in effect for that year on  ordinary  income and
the tax is subject          to an interest charge at the rate applicable to deficiencies
for income tax.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
entire amount of gain that was realized by a U.S. holder upon the sale or other
disposition of ordinary shares will also be rated as excess distribution and will be
subject to tax as described above.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
U.S. holders tax basis in Blue Squares shares that were acquired from a
decedent would not receive a step-up to fair market value as of the date of the decedents
death but would instead be equal to the decedents basis, if lower.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

106

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The
special PFIC rules described above will not apply to a U.S. holder if the U.S. holder
makes an election to treat us as a qualified electing fund, or QEF, in the
first taxable year in which the U.S. holder owns ordinary shares and if Blue Square
complies with certain reporting requirements. Instead, a shareholder of a qualified
electing fund 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. Blue Square has agreed to supply U.S. holders with the information needed
to report income and gain pursuant to a QEF election in the event Blue Square is
classified as PFIC. The QEF election is made on a shareholder-by-shareholder basis and can
be revoked only with the consent of the Internal Revenue Service, or IRS. A shareholder
makes a QEF election by attaching a completed IRS Form 8621, including the PFIC annual
information statement, to a timely filed United States federal income tax return and by
filing that form with the IRS Service Center in Philadelphia, Pennsylvania. Even if a QEF
election is not made, a shareholder in a PFIC who is a U.S. person must file a completed
IRS Form 8621 every year.

Alternatively,
a U.S. holder of PFIC stock which is publicly traded could elect to mark the
stock-to-market annually, recognizing as ordinary income or loss each year an amount equal
to the difference as of the close of the taxable year between the holders fair
market value of the PFIC stock and the adjusted basis in the PFIC stock. Losses would be
allowed only to the extent of net mark-to-market gain previously included by the U.S.
holder under the election for prior taxable years. If the mark-to-market election were
made, then the rules set forth above would not apply for periods covered by the election.
However, the character of any gain or loss realized by a U.S. holder on the disposition of
ordinary shares of a foreign corporation that does not qualify as a PFIC for the year of
disposition (but for which an election to apply the mark-to-market regime had been made in
a prior year) is capital.

Blue
Square believes that it was not a PFIC in 2005. However, the tests for determining PFIC
status are applied annually and it is difficult to make accurate predictions of future
income and assets, which are relevant to this determination. Accordingly, there can be no
assurance that Blue Square will not become a PFIC. If Blue Square determines that it has
become a PFIC, Blue Square will notify its U.S. holders and provide them with the
information necessary to comply with the QEF rules. U.S. holders who hold ordinary shares
during a period when Blue Square is a PFIC will be subject to the foregoing rules, even if
Blue Square ceases to be a PFIC, subject to certain exceptions for U.S. holders who made a
QEF election. U.S. holders are urged to consult their tax advisors about the PFIC rules,
including the consequences to them of making a mark-to-market or QEF election with respect
to Blue Squares ordinary shares and ADSs in the event that Blue Square qualifies as
a PFIC.

Tax
Consequences for Non-U.S. Holders of Ordinary Shares

Except
as described in Information Reporting and Back-up Withholding below, a
Non-U.S. holder of ADSs or ordinary shares will not be subject to U.S. federal income or
withholding tax on the payment of dividends on, and the proceeds from the disposition of,
ordinary shares, unless:

107

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| | such
item is effectively connected with the conduct by the Non-U.S. holder of a trade or
business in the United States and, in the case of a resident of a country which has a
treaty with the United States, such item 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 ADSs or the ordinary 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 does not qualify for an exemption; or
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
 Non-U.S.  holder is subject  to tax  pursuant  to the  provisions  of United  States tax
law          applicable to U.S. expatriates.
|- | ------------------------------------------------------------------------------------------------------------------------------------------

Information
Reporting and Back-up Withholding

U.S.
          holders generally are subject to information reporting requirements with
respect           to dividends paid in the United States on ADSs or ordinary shares. U.S.
holders           are also generally subject to back-up withholding at a rate of up to
25% on           dividends paid in the United States on ordinary shares unless the U.S.
holder           provides IRS Form W-9 or otherwise establishes an exemption. U.S.
holders are           subject to information reporting and back-up withholding at a rate
of up to 25%           on proceeds paid from the disposition of ADSs or ordinary shares
unless the U.S.           holder provides IRS Form W-9 or otherwise establishes an
exemption.

Non-U.S.
          holders generally are not subject to information reporting or back-up
          withholding with respect to dividends paid on, or upon the disposition of, ADSs
          or ordinary 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 back-up withholding will be allowed as a credit against a U.S. or 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.

| | F. | Dividends
and Paying Agents.
| | -- | ----------------------------

Not
applicable.

| | G. | Statement
by Experts.
| | -- | ---------------------

Not
applicable.

108

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| | 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.

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 in the amount of approximately NIS 35 million bear interest
at fixed rates, and therefore changes in the interest rates will affect the fair value of
such loans. Other loans set forth below and a deposit of NIS 500 million 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.

109

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The
table below provides information about Blue Squares financial instruments as of
December 31, 2005:

|                                       | December 31, 2005
Expected Maturity (NIS in thousands)
|-------------------------------------- | ------------------------------------------------------
|
|
|
|
|Long term loan from banks - linked:    |                                                       
|                                       |                                                       
|Linked to the Swiss Frank              |                                                       
|(annual interest rate of 2.33%)        |                                                       
|Linked to the Israeli CPI - 5.1%       |                                                       
|(weighted average rate as of           |                                                       
|December 31, 2005)                     |                                                       
|                                       |                                                       
|Long term loans from Bank -  unlinked: |                                                       
|                                       |                                                       
|Fixed annual interest rate of 6.67%    |                                                       
|                                       |                                                       
|Variable interest (average             |                                                       
|annual rate as of December 31,         |                                                       
|2005 - Prime minus 1.12%)              |                                                       
|                                       |                                                       
|                                       |                                                       
|                                       |                                                       
|Debentures - Linked to the             |                                                       
|Israeli CPI - fixed rate 5.9% (1)      |                                                       
|                                       |                                                       
|Convertible Debentures Linked to       |                                                       
|the Israeli CPI - fixed rate 5.9% (1)  |                                                       

(1) See also "Item 5.  Operating
 and Financial  Review and Prospects - Liquidity and Capital  Resources -     Debentures".

For
variable  interest rate loans, a one percent interest rate increase  (decrease),  taking
into account the NIS 500 million  deposit,  would cause an approximately  NIS 1 million
decrease  (increase) in net income for the next year.

For
CPI linked  financial  instruments as stipulated in the table above,  a one  percent
increase (decrease) in the CPI would cause an approximately  NIS 4.8 million decrease
 (increase) in net income for the next year.

Inflation Risks and Exchange Rate Risks

In
 accordance  with  Israeli  Accounting  Standard  No. 12  adopted  by the  Israeli
 Accounting Standards  Board,  our  financial  statements  ceased to be adjusted  for
 inflation in Israel for periods beginning on or after January 1, 2004.  The amounts
 included in our  financial  statements as of December 31, 2003 served as the starting
 point for nominal  financial  reporting  beginning  January 1, 2004.  The adoption of
Standard No. 12 could have material  adverse effect on our results of operations.  As a
result of the adoption of this standard,  our assets and revenues  ceased to be adjusted
for inflation in Israel, while the repayment of interest and principal  under most of our
loans and all debentures  continues to be linked to the Israeli CPI as provided in our
loan and debenture  agreements.  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.

110

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The
table below provides information about the CPI and the "known index":

|     | CPI | The "known index"
|---- | --- | -----------------
|
|
|
|
|2003 |     |                  
|2004 |     |                  
|2005 |     |                  

The
table below provides an analysis of monetary assets and liabilities by currency and
linkage as of December 31, 2005

|                                                        | Israeli Currency | Other Currencies
especially the
Dollar | Other
|------------------------------------------------------- | ---------------- | -------------------------------------- | -----
|
|
|
|
|Cash and cash equivalents                               |                  |                                        |      
|Trade receivables                                       |                  |                                        |      
|Other accounts receivables                              |                  |                                        |      
|Restricted deposit                                      |                  |                                        |      
|Investments in an associated company                    |                  |                                        |      
|Other Long-term receivables                             |                  |                                        |      
|                                                        |                  |                                        |      
|                                                        |                  |                                        |      
|Short-term credit from banks                            |                  |                                        |      
|Trade payables                                          |                  |                                        |      
|Other accounts payables and accrued expenses            |                  |                                        |      
|Long term loans from banks including current maturities |                  |                                        |      
|Debentures                                              |                  |                                        |      
|Convertible debentures                                  |                  |                                        |      
|                                                        |                  |                                        |      
|                                                        |                  |                                        |      
|                                                        |                  |                                        |      
|Monetary liabilities, net                               |                  |                                        |      
|                                                        |                  |                                        |      

|ITEM 12. | DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES
|-------- | ------------------------------------------------------

Not
applicable.

111

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# 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 Act of 1933, 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)
Internal Control Over Financial Reporting. There were no changes in our
          internal control over financial reporting that occurred during the year ended
          December 31, 2005 that have materially affected, or are reasonably likely to
          materially affect, our internal control over financial reporting.

|ITEM 16. | [RESERVED]
|-------- | ----------

|ITEM 16A. | AUDIT
COMMITTEE FINANCIAL EXPERT
|--------- | --------------------------------

The
Board of Directors has determined that Shlomo Even 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.

112

---

---



|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. | ACCOUNTANTS FEES
AND SERVICES
|--------- | ------------------------------

Kesselman
& Kesselman, a member of PricewaterhouseCoopers International Limited, served as our
independent public accountants for the fiscal years ended December 31, 2004 and 2005, 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 2004 and
2005.

|                   | 2004 | 2005
|------------------ | ---- | ----
|
|
|
|
|Audit Fees (1)     |      |     
|Tax Fees (2)       |      |     
|All Other Fees (3) |      |     
|                   |      |     
|TOTAL              |      |     

| | (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; and
assistance with and review of documents filed with the SEC.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | 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.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | All
Other Fees include fees billed in  connection  with the  following:  the transfer by
                  the  Company  of real  estate  assets to BSRE,  a new  wholly  owned
 subsidiary  of the                   Company;  data security review,  Sarbanes-Oxley
 Act compliance,  and accounting  advice                   services in connection with
several Company transactions.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

113

---

---



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 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.
|--------- | -----------------------------------------------------------------------

Below
is a list of purchases of the Company's  ordinary shares by  Bronfman-Alon  during
calendar year 2005:

|Period                       | Total Number of
Shares Purchased | Average Price
Paid Per Share
(in NIS) | Total Number of
Shares Purchased
as Part of
Publicly Announced
Plans or Programs | Maximum Number of
Shares that May
Yet Be Purchased
Under Plans or
Programs
|---------------------------- | -------------------------------- | ------------------------------------- | -------------------------------------------------------------------------------- | --------------------------------------------------------------------------
|June 26, 2005-June 30, 2005  | 16,406                           | 39.65                                 | N/A                                                                              | N/A                                                                       
|July 4, 2005-
July 21, 2005  | 92,209                           | 43.52                                 | N/A                                                                              | N/A                                                                       
|Aug. 23, 2005-
Aug. 31, 2005 | 73,826                           | 46.47                                 | N/A                                                                              | N/A                                                                       
|Sept. 1, 2005-
Sept. 6, 2005 | 57,408                           | 46.35                                 | N/A                                                                              | N/A                                                                       

114

---

---



# 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. |  | Description
|----------- |  | -----------

|1.1 |  | 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 adopted in August 2001 (incorporated by reference to
Exhibit 1.2 to Blue Squares Annual Report on Form 20-F for the year ended December
31, 2001).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.3 |  | Amendments
to Articles of Association of the Registrant adopted in January 2004 (incorporated by
reference to Exhibit 1.3 to Blue Squares Annual Report on Form 20-F for the year
ended December 31, 2003).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.4 |  | Amendment
to Articles of Association of the Registrant adopted in February 2006.
|--- |  | --------------------------------------------------------------------------------

|2.1 |  | Form
of Deposit Agreement  (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)).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

115

---

---



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

|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)).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | 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 |  | 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)).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | 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).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.13 |  | 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).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.14 |  | 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).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.15 |  | 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, 2005).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Loan
Agreement made on the 5th day of June 1996 between the Registrant and Blue Square Chain
Investments & Properties Ltd. (incorporated by reference to Exhibit 10.5 to the
Registration Statement on Form F-1 (File No. 333-05024)).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | 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).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

116

---

---



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

|4.18 |  | 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).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.19 |  | 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).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.20 |  | 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).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.21 |  | 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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8 |  | List
of Subsidiaries.
|- |  | ---------------------

|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.
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

117

---

---



# BLUE SQUARE 
ISRAEL LTD.

# 2005 ANNUAL REPORT



---

---



BLUE SQUARE  ISRAEL
LTD. 
2005 ANNUAL REPORT

TABLE OF CONTENTS

|                                                                            | Page       
|--------------------------------------------------------------------------- | -----------
|
|
|
|
|REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS                   | F-2 - F-3  
|                                                                           
|CONSOLIDATED FINANCIAL STATEMENTS IN THOUSANDS OF NEW ISRAELI SHEKEL (NIS):
|                                                                           
|Balance sheets                                                              | F-4 - F-5  
|                                                                           
|Statements of operations                                                    | F-6        
|                                                                           
|Statements of changes in shareholders' equity                               | F-7        
|                                                                           
|Statements of cash flows                                                    | F-8 - F-9  
|                                                                           
|Notes to financial statements                                               | F-10 - F-60
|                                                                           
|APPENDIX I - DETAILS OF PRINCIPAL SUBSIDIARIES, PROPORTIONATELY            
|CONSOLIDATED COMPANIES AND AN ASSOCIATED COMPANY                            | F-61       
|                                                                           
|APPENDIX II  - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     
|for subsidiary of the Company, Hamachsan Hamerkazi Kfar Hashaasuim Ltd.     | F-62       



---

---



|
|
|

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of

# BLUE SQUARE 
ISRAEL LTD

We have audited the accompanying
consolidated financial statements of Blue Square  Israel Ltd. (hereafter  the
Company) and its subsidiaries and proportionately consolidated companies: consolidated
balance sheets as of December 31 ,2005 and 2004 and the related consolidated statements of
operations, changes in shareholders equity and cash flows for each of the two years
in the period ended December 31, 2005. These 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 audits.

We did not audit the financial
statements of a certain subsidiary, whose assets included in consolidation constitute
approximately 3.64% of total consolidated assets as of December 31, 2005, and whose
revenues included in consolidation constitute approximately 1.57% of total consolidated
revenues for the year ended December 31, 2005. The financial statements of the above
subsidiary were audited by other independent registered public accounting firm, whose
report have been furnished to us, and our opinion, insofar as it relates to amounts
included for that company, is based on the report of the other independentregistered public accounting firm.

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

In our opinion, based on our audits
and the report of the other independent registered public accounting firm, the
consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of the Company and its subsidiaries as of
December 31, 2005 and 2004 and the consolidated results of operations, and cash flows for
each of the two years in the period ended December 31, 2005, in conformity with accounting
principles generally accepted in Israel.

Accounting principles generally
accepted in Israel vary in certain significant respects from accounting principles
generally accepted in the United States and as allowed by item 17 to Form 20-F. 
Information relating to the nature and effect of such differences is presented in note 18
to the consolidated financial statements.

As explained in note 2a, the
financial statements, as of dates and for reporting periods subsequent to December 31,
2003, are presented in New Israeli Shekels, in conformity with accounting standards issued
by the Israel Accounting Standards Board. The financial statements for reporting periods
ended prior to, or on the above date, are presented in values that have been adjusted for
the changes in the general purchasing power of the Israeli currency through that date, in
accordance with pronouncements of the Institute of Certified Public Accountants in Israel.

|               |                            
|-------------- | ---------------------------
|
|
|
|
|Tel-Aviv       | /S/ Kesseleman&Kesselman   
|March 21, 2006 | Public Accounting Certified

F - 2

---

---



| | n | Kost Forer Gabbay & Kasierer           | n | Phone: 972-3-6232525
| | - | -------------------------------------- | - | --------------------
| |   | 3 Aminadav St. 
Tel-Aviv 67067, Israel |   | Fax: 972-3-5622555  

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Shareholders of

# BLUE SQUARE 
ISRAEL LTD.

We
have audited the accompanying consolidated statements of operations, changes in
shareholders equity and cash flows of Blue Square  Israel Ltd. (the
Company) and subsidiaries for the year ended December 31, 2003. These
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 audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States) and generally accepted auditing standards in Israel,
including those prescribed under the Auditors Regulations (Auditors Mode of
Performance), 1973. 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 consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by the Board of Directors and management and evaluating the
overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the consolidated results of operations, changes in
shareholders equity and cash flows of the Company and subsidiaries, for the year
ended December 31, 2003, in conformity with accounting principles generally accepted in
Israel, which differ in certain respects from those generally accepted in the United
States (see Note 18 to the consolidated financial statements).

As
described in Note 2a, the consolidated financial statements referred to above are
presented in values adjusted for the changes in the general purchasing power of the
Israeli currency, in accordance with pronouncements of the Institute of Certified Public
Accountants in Israel.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|Tel-Aviv, Israel | /S/ KOST FORER GABBAY & KASIERER
|March 8, 2004    | A Member of Ernst & Young Global

F - 3

---

---



BLUE SQUARE 
ISRAEL LTD. 
CONSOLIDATED BALANCE
SHEETS

|                                               |  |  |  | Conveniencetranslation(note 2p)
|---------------------------------------------- |  |  |  | -------------------------------
|
|
|
|
|
|A  s  s  e  t  s                               |  |  |  | 11                             
|                                               |  | 
|CURRENT ASSETS:                                |  |  |  | 13                             
|Cash and cash equivalents                      |  |  |  | 2c                             
|Trade receivables                              |  |  |  | 15a                            
|Other accounts receivable                      |  |  |  | 15b                            
|Inventories                                    |  |  |  | 15c                            
|                                               |  |  |  |                                
|                                               |  | 
|Total current assets                           |  |  |  |                                
|                                               |  |  |  |                                
|                                               |  | 
|INVESTMENTS AND LONG TERM RECEIVABLES:         |  | 
|Restricted deposit                             |  |  |  | 11c                            
|Investments in an associated company           |  |  |  | 3                              
|Other long term receivables                    |  |  |  | 15d                            
|                                               |  |  |  |                                
|                                               |  |  |  |                                
|                                               |  |  |  |                                
|                                               |  | 
|FIXED ASSETS, NET OF ACCUMULATED DEPRECIATION  |  | 
|AND AMORTIZATION                               |  |  |  | 4                              
|                                               |  |  |  |                                
|                                               |  | 
|OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION: |  |  |  | 5                              
|Goodwill                                       |  |  |  |                                
|Deferred charges                               |  |  |  |                                
|                                               |  |  |  |                                
|                                               |  | 
|                                               |  |  |  |                                
|                                               |  |  |  |                                
|                                               |  | 
|                                               |  |  |  |                                
|                                               |  |  |  |                                

|March 21, 2006Date of approval of thefinancial statements | /S/ David WiessmanChairman of the Boardof Directors | /S/ Gil Unger Chief Executive Officer | /S/ Emanuel AvnerVice President andChief Financial Officer
|------------------------------------------------------------------ | ------------------------------------------------------------ | ---------------------------------------------- | -------------------------------------------------------------------

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

F - 4

---

---



BLUE SQUARE 
ISRAEL LTD. 
CONSOLIDATED BALANCE
SHEETS

|                                             |  |  |        | Conveniencetranslation(note 2p)
|-------------------------------------------- |  |  | ------ | -------------------------------
|
|
|
|
|
|Liabilities and shareholders' equity         |  |  |        |                                
|                                             |  | 
|CURRENT LIABILITIES:                         |  |  | 11, 13 |                                
|Credit and loans from banks                  |  |  | 15e    |                                
|Current maturities of debentures             |  |  | 7      |                                
|Trade payables                               |  |  |        |                                
|Other accounts payable and accrued expenses  |  |  | 15f    |                                
|Dividend payable                             |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|Total current liabilities                    |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|LONG-TERM LIABILITIES:                       |  | 
|Long-term loans from banks, net of current   |  | 
|maturities                                   |  |  | 6      |                                
|Debentures, net of current maturities        |  |  | 7      |                                
|Convertible debentures                       |  |  | 7      |                                
|Deferred income taxes                        |  |  | 12b    |                                
|Liability for employee rights, net of amount |  | 
|funded                                       |  |  | 8      |                                
|                                             |  |  |        |                                
|                                             |  | 
|Total long-term liabilities                  |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|CONTINGENT LIABILITIES AND COMMITMENTS       |  |  | 9      |                                
|Total liabilities                            |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|MINORITY INTEREST                            |  |  | 15g    |                                
|                                             |  |  |        |                                
|                                             |  | 
|SHAREHOLDERS' EQUITY:                        |  |  | 10     |                                
|Share capital -                              |  | 
|Ordinary shares of NIS 1 par value -         |  | 
|Authorized: 100,000,000 shares at December   |  | 
|31, 2005 and 2004; Issued and outstanding    |  | 
|38,950,091 and 38,782,336 shares at          |  | 
|December 31, 2005 and 2004, respectively     |  |  |        |                                
|Additional paid-in capital                   |  |  |        |                                
|Retained earnings:                           |  | 
|Dividend declared subsequent to balance      |  | 
|sheet date                                   |  |  |        |                                
|Unappropriated                               |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|Total shareholders equity                    |  |  |        |                                
|                                             |  |  |        |                                
|                                             |  | 
|                                             |  |  |        |                                
|                                             |  |  |        |                                

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

F - 5

---

---



BLUE SQUARE 
ISRAEL LTD. 
CONSOLIDATED STATEMENTS
OF OPERATIONS

|                                         |  | 2003 | 2004 | 2005 | Conveniencetranslation(note 2p)2005
|---------------------------------------- |  | ---- | ---- | ---- | -----------------------------------
|
|
|
|
|
|Sales                                    |  |      | 2m   |      |                                    
|Cost of sales                            |  |      |      |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Gross profit                             |  |      |      |      |                                    
|Selling, general and administrative      |  |     
|expenses                                 |  |      | 15h  |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Operating income                         |  |      |      |      |                                    
|Financial expenses, net                  |  |      | 15i  |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|                                         |  |      |      |      |                                    
|                                         |  |     
|Amortization of goodwill                 |  |      |      |      |                                    
|Other income (expenses), net             |  |      | 15j  |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Income before taxes on income            |  |      |      |      |                                    
|Taxes on income                          |  |      | 12d  |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Income after taxes on income             |  |      |      |      |                                    
|Share in profits (losses) of associated  |  |     
|company, net                             |  |      |      |      |                                    
|Minority interest in profits of          |  |     
|subsidiaries, net                        |  |      |      |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Net income (loss) for the year           |  |      |      |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Net income (loss) per Ordinary share or  |  |     
|ADS                                      |  |      | 2t   |      |                                    
|                                         |  |      |      |      |                                    
|                                         |  |     
|Weighted average number of shares or ADS |  |     
|used for computation of income (loss)    |  |     
|per share                                |  |      |      |      |                                    
|                                         |  |      |      |      |                                    

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

F - 6

---

---



BLUE SQUARE 
ISRAEL LTD. 
STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY

|                                        |  |  | Retained earnings |       
|--------------------------------------- |  |  | ----------------- | ------
|
|
|
|
|
|BALANCE AT JANUARY 1, 2003              |  |  |                   | 52,121
|                                        |  | 
|CHANGES DURING 2003:                    |  | 
|                                        |  | 
|Dividend paid                           |  |  |                   | -     
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                   | -     
|Net loss                                |  |  |                   | -     
|                                        |  |  |                   |       
|                                        |  | 
|BALANCE AT DECEMBER 31, 2003            |  |  |                   | 52,121
|                                        |  | 
|CHANGES DURING 2004:                    |  | 
|                                        |  | 
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                   | 382   
|Dividend paid                           |  |  |                   | -     
|Dividend declared                       |  |  |                   | -     
|Net income                              |  |  |                   | -     
|                                        |  |  |                   |       
|                                        |  | 
|BALANCE AT DECEMBER 31, 2004            |  |  |                   | 52,503
|                                        |  | 
|CHANGES DURING 2005:                    |  | 
|                                        |  | 
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                   | 168   
|Reclassification of capital reserve     |  | 
|related to capital gain from            |  | 
|transaction with previous parent        |  | 
|cooperative (see note 10 c)             |  |  |                   | -     
|Gain on derivatives hedging dividend    |  | 
|payable, net of taxes                   |  |  |                   | -     
|Dividend paid                           |  |  |                   | -     
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                   | -     
|Net income                              |  |  |                   | -     
|                                        |  |  |                   |       
|                                        |  | 
|BALANCE AT DECEMBER 31, 2005            |  |  |                   | 52,671
|                                        |  |  |                   |       

|                                            | Convenience translation into U.S. dollars in thousands (note 2p)
|------------------------------------------- | ----------------------------------------------------------------
|
|
|
|
|
|BALANCE AT JANUARY 1, 2005                  |                                                                 
|                                            |                                                                 
|CHANGES DURING 2005:                        |                                                                 
|Issuance of shares upon conversion of       |                                                                 
|convertible debentures                      |                                                                 
|Reclassification of capital reserve         |                                                                 
|elated to apital gain from transaction with |                                                                 
|revious arent cooperative (see note 10 c)   |                                                                 
|Gain on derivatives hedging dividend        |                                                                 
|payable, net of taxes                       |                                                                 
|Dividend paid                               |                                                                 
|Dividend declared subsequent to balance     |                                                                 
|sheet date                                  |                                                                 
|Net income                                  |                                                                 
|                                            |                                                                 
|                                            |                                                                 
|BALANCE AT DECEMBER 31, 2005                |                                                                 
|                                            |                                                                 

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

F - 7

---

---



(Continued)  1

BLUE SQUARE 
ISRAEL LTD. 
CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                        |  |  |  | Conveniencetranslation(note 2p)
|------------------------------------------------------- |  |  |  | -------------------------------
|
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                   |  |  |  |                                
|                                                        |  | 
|Net income (loss)                                       |  |  |  | (7,046                         
|Adjustments required to reflect the cash flows          |  | 
|from  operating activities (a)                          |  |  |  | 265,586                        
|                                                        |  |  |  |                                
|                                                        |  | 
|Net cash provided by operating activities               |  |  |  | 258,540                        
|                                                        |  |  |  |                                
|                                                        |  | 
|CASH FLOWS FROM INVESTING ACTIVITIES:                   |  | 
|                                                        |  | 
|Purchase of fixed assets                                |  |  |  | (138,713                       
|Investment in restricted deposit and long-term          |  | 
|receivables                                             |  |  |  |                                
|Acquisition of minority interest in subsidiary          |  |  |  | (865                           
|Proceeds from sale of fixed assets                      |  |  |  | 29,513                         
|Deconsolidation of former investee company (c)          |  |  |  | -                              
|Proceeds from realization of investment in former       |  | 
|investee company (see note 3c):                         |  | 
|Consideration for shares sold                           |  |  |  | -                              
|Amount received for assumed liabilities to              |  | 
|banks and others                                        |  |  |  | -                              
|Acquisition of a subsidiary consolidated for the        |  | 
|first time (b)                                          |  |  |  | -                              
|Proceeds from sale of (investments in) marketable       |  | 
|securities, net                                         |  |  |  | (11,572                        
|Long term loan to a former investee company, net        |  |  |  | -                              
|                                                        |  |  |  |                                
|                                                        |  | 
|Net cash used in investing activities                   |  |  |  | (121,637                       
|                                                        |  |  |  |                                
|                                                        |  | 
|CASH FLOWS FROM FINANCING ACTIVITIES:                   |  | 
|                                                        |  | 
|Dividends paid to shareholders                          |  |  |  | (295,030                       
|Dividend paid to minority shareholders of               |  | 
|subsidiaries                                            |  |  |  | -                              
|Decrease in the balance with previous parent            |  | 
|cooperative, net                                        |  |  |  | (5,471                         
|Receipt of long-term loans                              |  |  |  | 109,629                        
|Repayments of long-term loans and  debentures           |  |  |  | (203,492                       
|Repayment of capital note to previous shareholders      |  | 
|of subsidiary                                           |  |  |  | -                              
|Issuance of debentures and convertible debentures,      |  | 
|net of issuance expenses                                |  |  |  | 393,047                        
|Short-term credit from banks, net                       |  |  |  | (86,038                        
|                                                        |  |  |  |                                
|                                                        |  | 
|Net cash provided by (used in) financing activities     |  |  |  | (87,355                        
|                                                        |  |  |  |                                
|                                                        |  | 
|INCREASE (DECREASE) IN CASH AND CASH     EQUIVALENTS    |  |  |  | 49,548                         
|BALANCE OF CASH AND CASH EQUIVALENTS AT                 |  | 
|BEGINNING OF YEAR                                       |  |  |  | 13,707                         
|                                                        |  |  |  |                                
|                                                        |  | 
|BALANCE OF CASH AND CASH EQUIVALENTS AT     END OF YEAR |  |  |  | 63,255                         
|                                                        |  |  |  |                                
|                                                        |  | 
|SUPPLEMENTAL DISCLOSURE OF CASH     FLOW ACTIVITIES:    |  | 
|                                                        |  | 
|Cash paid during the year for interest                  |  |  |  | 31,462                         
|                                                        |  |  |  |                                
|                                                        |  | 
|Cash paid during the year for taxes                     |  |  |  | 40,861                         
|                                                        |  |  |  |                                

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

F - 8

---

---



(Concluded)  2

BLUE SQUARE 
ISRAEL LTD. 
CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                           | 2003 | 2004 | 2005 | Convenience
translation
(note 2p)
2005
|---------------------------------------------------------- | ---- | ---- | ---- | --------------------------------------
|
|
|
|
|
|(a) Adjustments required to reflect the cash flows from    |      |      |      |                                       
|operating activities:                                      |      |     
|                                                           |      |     
|Income and expenses not involving cash flows:              |      |     
|Depreciation and amortization                              |      |      |      | 145,190                               
|Minority interest in profits of subsidiaries - net         |      |      |      | 10,852                                
|Share in losses (profits) of an associated company         |      |      |      | (742                                  
|Loss (gain) from sale, disposal and impairment of          |      |     
|fixed assets and investments                               |      |      |      | 47,359                                
|Deferred income taxes, net                                 |      |      |      | (16,571                               
|Linkage differences on long-term loans and other           |      |     
|liabilities, net                                           |      |      |      | 8,530                                 
|Increase in liability for employee rights, net             |      |      |      | 14,735                                
|Increase in value of marketable securities, deposit        |      |     
|and long term receivables                                  |      |      |      | (3,565                                
|Capital gain from sale of a former investee company        |      |     
|(see note 3c)                                              |      |      |      | -                                     
|Changes in operating assets and liabilities:               |      |     
|Decrease (increase) in trade receivables and other         |      |     
|accounts receivable                                        |      |      |      | (22,025                               
|Decrease (increase) in inventories                         |      |      |      | 54,161                                
|Increase (decrease) in trade payables and other            |      |     
|accounts payable                                           |      |      |      | 27,662                                
|                                                           |      |      |      |                                       
|                                                           |      |     
|                                                           |      |      |      | 265,586                               
|                                                           |      |      |      |                                       
|                                                           |      |     
|(b) Acquisition of a subsidiary consolidated for the first |      |     
|time:                                                      |      |     
|                                                           |      |     
|Assets and liabilities of the subsidiary at date of        |      |     
|acquisition:                                               |      |     
|Working capital (excluding cash and cash equivalents)      |      |      |      | -                                     
|Fixed assets                                               |      |      |      | -                                     
|Deferred income taxes                                      |      |      |      | -                                     
|Liability for employee rights upon retirement - net        |      |      |      | -                                     
|Long-term loans and other liabilities                      |      |      |      | -                                     
|Goodwill arising on acquisition                            |      |      |      | -                                     
|Minority interest in subsidiary at date of                 |      |     
|acquisition                                                |      |      |      | -                                     
|                                                           |      |      |      |                                       
|                                                           |      |      |      | -                                     
|                                                           |      |      |      |                                       
|(c) Deconsolidation of former investee company             |      |     
|                                                           |      |     
|Assets and liabilities of this company at date of          |      |     
|deconsolidation:                                           |      |     
|Working capital deficiency (excluding cash and cash        |      |     
|equivalents)                                               |      |      |      | -                                     
|Fixed assets and investments                               |      |      |      | -                                     
|Long term liabilities                                      |      |      |      | -                                     
|Carrying amount of the investment at the date of the       |      |     
|deconsolidation                                            |      |      |      | -                                     
|                                                           |      |      |      |                                       
|                                                           |      |      |      | -                                     
|                                                           |      |      |      |                                       
|                                                           |      |     
|(d) Supplementary information on investing and financing   |      |     
|activities not involving cash flows:                       |      |     
|                                                           |      |     
|Sale of fixed assets on credit                             |      |      |      | 21,861                                
|                                                           |      |      |      |                                       
|Purchase of partner's interest in partnership in           |      |     
|consideration for deposit                                  |      |      |      | 6,854                                 
|                                                           |      |      |      |                                       
|Issuance of shares upon conversion of convertible          |      |     
|debentures                                                 |      |      |      | -                                     
|                                                           |      |      |      |                                       
|Dividend payable                                           |      |      |      | -                                     
|                                                           |      |      |      |                                       

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

F - 9

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 1 |  | GENERAL:
|------ | - | --------

| | a. | Nature
of operations
| | -- | --------------------

| | Blue
Square-Israel Ltd. (Blue Square) is an Israeli corporation, which,
independently and through its subsidiaries, operates in one business segment  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,
apparel, pharmaceuticals, housewares and cosmetics.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Acquisition
of controlling interest in the Company
| | -- | --------------------------------------------------

| | In
April 2003, the Tel Aviv District Court announced that Bronfman-Alon Ltd. had been
awarded the tender for the acquisition of the shares of the Company held by Co-Op Blue
Square Services Society Ltd. (the previous parent cooperative or Co-Op).
Co-Op held approximately 78% of the shares of the Company. In June 2003 the acquisition
was completed.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | The
Company intends to reorganize its real estate operations such that Blue
               Squares real estate will be transferred to a new wholly-owned
subsidiary                that was established for this purpose. This reorganization
depends on the                Israeli Tax Authority approval. See also note 9b(2).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Use
of estimates in the preparation of financial statements
| | -- | -----------------------------------------------------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Definitions:
| | -- | ------------

| | Subsidiary | - | a company over which the Company has control,  the financial  statements of
which have been consolidated with the financial  statements of the Company,
which is not a proportionately consolidated company.
| | ---------- | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Proportionately
consolidated   
company | - | a jointly  controlled  company,  none of the  shareholders  of which  holds
exclusive control,  the financial statements of which are consolidated with
those of the Company by the proportionate consolidation method.
| | --------------------------------------- | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Associated company | - | a company  (which is not a  subsidiary  or a  proportionately  consolidated
company),  over whose financial and  operational  policy the Company exerts
material  influence,  the  investment  in which is  presented by the equity
method.  Material  influence is deemed to exist when the percentage holding
in the said  company is 20% or more,  unless there are  circumstances  that
contradict this assumption.
| | ------------------ | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---

BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 1 |  | GENERAL(continued):
|------ | - | -------------------

| | Investee company | - | a subsidiary, proportionately consolidated company or associated company.
| | ---------------- | - | -------------------------------------------------------------------------

| | Related parties | - | as defined in Opinion  No.29 of the Israeli  Institute Of Certified  Public
Accountant.
| | --------------- | - | ---------------------------------------------------------------------------------------

| | Goodwill | - | the difference  between the cost of the investment in the investee  company
and the Company's share in the fair value of its underlying  assets, net of
the fair value of its underlying liabilities,  at time of acquisition,  net
of the applicable taxes.
| | -------- | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES:
|------ | - | --------------------------------

| | The
consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in Israel (Israeli GAAP). Israeli GAAP vary in certain
significant respects from accounting principles generally accepted in the United States
of America. Information relating to the nature and the effect of such differences is
presented in note 18.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
significant accounting policies which, except for the changes required by the transition
to nominal financial reporting in 2004 (see a (1)), were applied on a consistent basis,
are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Financial
statements presentation basis:
| | -- | ----------------------------------------

| | The
Company draws up and presents its financial statements in Israeli currency (hereafter
 shekels or NIS).
| | ------------------------------------------------------------------------------------------------------------

| | 1) | Transition
to nominal financial reporting in 2004
| | -- | -------------------------------------------------

| | With
effect from January 1, 2004, the Company has adopted the provisions of Israel Accounting
Standard No. 12 Discontinuance of Adjusting Financial Statements for Inflation  of
the Israel Accounting Standards Board (hereafter the IASB) and, pursuant thereto,
the Company has discontinued, from the aforesaid date, the adjustment of its financial
statements for the effects of inflation in Israel.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amounts adjusted for the effects of inflation in Israel, presented in the financial
statements as of December 31, 2003 (hereafter  the transition date),
were used as the opening balances for the nominal financial reporting in the following
periods. Accordingly, the amounts reported in these financial statements, that relate to
non-monetary assets (including the depreciation and amortization thereon), investments in
associated company (see also g below) and equity items, which originate from the period
that preceded the transition date, are based on the adjusted-for-inflation data (based on
the CPI for December 2003), as previously reported.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
the amounts originating from the period after the transition date are included in the
financial statements based on their nominal values.
| | ---------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | Through
December 31, 2003, the Company prepared its financial statements on the basis of
historical cost adjusted for the changes in the general purchasing power of Israeli
currency (NIS), based upon changes in the consumer price index (hereafter
 the CPI, see also note 13b), in accordance with pronouncements of the
Institute of Certified Public Accountants in Israel (hereafter  the Israeli
Institute).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Components
of the income statements for 2003 were, for the most part, adjusted as follows: the
components relating to transactions carried out during the reported period  sales,
purchases, labor costs, etc.  were adjusted on the basis of the index for the month
in which the transaction was carried out, while those relating to nonmonetary balance
sheet items (mainly  changes in inventories and depreciation and amortization) were
adjusted on the same basis as the related balance sheet item. The financing component
represents financial income and expenses in real terms and the erosion of balances of
monetary items during the year.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | The
amounts of non-monetary assets do not necessarily represent realization           value
or current economic value, but only the reported amounts of such assets,           as
described in (1) above. In these financial statements, the term           cost signifies
cost in reported amounts.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Principles
of consolidation:
| | -- | ----------------------------

| | 1) | The
consolidated financial statements include the accounts of the Company and           its
subsidiaries; as to a company consolidated for the first time, see note 3a.           The
companies included in consolidation are listed in appendix I to the           financial
statements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
addition to the fully consolidated companies as above, the consolidated
          financial statements include jointly controlled companies that have been
          consolidated by the proportionate consolidation method, as prescribed by
          Opinion 57 of the Israeli Institute. As to data relating to such companies
          included in these consolidated financial statements  see also note 3c.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | Goodwill
is presented in the consolidated balance sheets under other           assets and
is amortized in equal annual installments over 10 and 20 years           (mainly 20
years), commencing in the year of acquisition. Pursuant to an           amendment to
Israel Accounting Standard No. 20, which was issued in March 2006,           the
amortization of goodwill is to be discontinued from January 1, 2006           see w
(5) below.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | Intercompany
balances and transactions have been eliminated. Profits from           intercompany
sales, not yet realized outside the group, have also been           eliminated.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Cash
equivalents
| | -- | ----------------

| | The
Company considers all highly liquid investments, which include short-term bank deposits
(up to three months from date of deposit) that are not restricted as to withdrawal or use
to be cash equivalents.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | d. | Marketable
securities
| | -- | ---------------------

| | Marketable
securities are presented at market value. Changes in value are carried to financial
income or expenses.
| | ------------------------------------------------------------------------------------------------------------------

| | e. | Concentrations
of credit risks  allowance for doubtful accounts
| | -- | ----------------------------------------------------------------

| | The
Companys sales derive from a large number of customers and the trade receivables
consist mainly of receivables from credit card companies. Accordingly, the Companys
trade balances do not represent a substantial concentration of credit risks at December
31, 2005. Management regularly monitors the balance of trade receivables, and the
financial statements include a specific allowance computed for accounts, the
collectibility of which, in the view of management, is doubtful.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Inventories
| | -- | -----------

| | Inventories
(mainly merchandise) are stated at the lower of cost or market, cost being determined by
the first-in, first-out method. The Company evaluates inventory shrinkage
throughout the year based on the results of periodic physical counts in its stores, and
record reserves based on the results of these counts to provide for estimated shrinkage
as of the balance sheet date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | g. | Investment
in an associated company and in other company :
| | -- | ----------------------------------------------------------

| | 1) | Investment
in an associated company is accounted for by the equity method.
| | -- | --------------------------------------------------------------------------

| | 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 its investment, in the associated company.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | Investment
in other company for which the consolidation by the proportionate           consolidation
method has been discontinued in 2004, was presented in December           31, 2004 at its
carrying value as of the date of the discontinuance of its           consolidation. This
investment was realized in 2005  see also note 3(c).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. | Fixed
assets
| | -- | ------------

| | Fixed
assets are stated at cost net of accumulated depreciation and amortization. Improvements
are capitalized, whereas maintenance and repairs are charged to operations as incurred.
Borrowing costs in respect of credit applied to finance the construction or acquisition
of fixed assets incurred until construction of the fixed assets is completed  are
charged to cost of such assets.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | The
assets are depreciated by the straight-line method, on the basis of their estimated
useful life. Annual rates of depreciation are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| |                                        | %                            
| | -------------------------------------- | -----------------------------
|
|
|
|
| | Buildings                              | 2                            
| | Furniture, equipment and installations | 6 - 33 (mainly 10%)          
| | Motor vehicles                         | 15 - 20                      
| | Leasehold improvements                 | The lower of the term of the 
| |                                        | lease or the estimated useful
| |                                        | lives (mainly 10%)           

| | Fixed
assets include the cost of internal-use software. The Company expenses all costs related
to the development of internal-use software other than those incurred during the
application development stage. Costs incurred during the application development stage
are capitalized and amortized using the straight line method over the estimated useful
life of the software (generally 4 years).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Deferred
charges:
| | -- | -----------------

| | 1. | Prepaid
rental expenses and acquisition tax in respect of operating lease
               agreements are amortized over the remaining leasehold period.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Debenture
issuance costs  these costs are amortized over the term of the
               debentures, in proportion to their outstanding balance. As to the change
from                January 1, 2006, in the method of presenting and amortizing these
charges                see note w(1) below.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Goodwill
 see b (3) above.
| | -- | ---------------------------

| | j. | Impairment
of 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 an
impairment of fixed assets and identifiable intangibles, including goodwill.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 up to the
amount needed to adjust the carrying amount to the recoverable amount.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
recoverable value of an asset is determined according to the higher of the net selling
price of the asset or its value in use to the Company. The value in use is determined
according to the present value of anticipated cash flows from the continued use of the
asset, including those expected at the time of its future retirement and disposal. 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 determining the net selling price of an asset,
management relies on estimates of the Companys experts.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | When
it is not possible to assess whether an impairment provision is required for a particular
asset on its own, the need for such a provision is assessed in relation to the
recoverable value of the cash-generating unit to which that asset belongs. A
cash-generating unit includes goodwill allocated to that unit, and any impairment loss
relating to that unit is initially allocated to the goodwill and then to the other
assets.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company evaluates impairment separately for each store or other cash-generating unit. 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 to other units.
Goodwill is evaluated for impairment in relation to the cash generating unit to which the
goodwill can be allocated; mostly, goodwill is allocated to the operations of the Companys
principal consolidated subsidiary (Blue Square Chain Investments and Properties Ltd  BSIP).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
impairment loss is carried directly to statements of operations. Where indicators are
present that beneficial events have occurred or beneficial changes in circumstances have
taken place, the impairment provision in respect of the asset (other than goodwill) may
be cancelled or reduced in the future, so long as the recoverable value of the asset has
increased, as a result of changes in the estimates previously employed in determining
such value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to provisions for impairment recorded in previous years see note 4b. Pursuant to an
amendment to Accounting Standard No. 20 that was published in March 2006, goodwill and
certain intangible assets have to be tested for impairment at least once a year  see
note w (5) below.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | k. | Convertible
debentures
| | -- | ----------------------

| | The
debentures, which as of December 31, 2005 and 2004 are not expected to be converted, are
presented at the amount of the liability at the balance sheet date and are presented
among long-term liabilities. As to the implications of the initial adoption of Israel
Accounting Standard No. 22 in 2006, see w(1) below.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | l. | Deferred
taxes :
| | -- | ----------------

| | 1) | Commencing
January 1, 2005, the Company applies the IASBs Accounting           Standard No. 19
 Taxes on Income that prescribes the           accounting treatment
(recognition criteria, measurement, presentation and           disclosure) required for
taxes on income.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the most part, the provisions of this standard are the same as the accounting principles
that the Company applied prior to implementing the new standard. The adoption of this
standard does not have a material effect on the Companys financial statements in
the reported periods.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | 2) | In
accordance with the standard and with prior years policy, the Company
               recognizes deferred taxes in respect of temporary differences between the
               amounts of assets and liabilities as reported in the financial statements
and                those taken into account for tax purposes; the standard requires that
full                recognition be given to deferred taxes in respect of all taxable
temporary                differences, except for the temporary difference resulting from
the initial                recognition of goodwill and the temporary difference resulting
from the initial                recognition of an asset or a liability that has no effect
on the profit or loss,                whether for accounting or tax purposes, at that
time (unless the temporary                difference results from the initial recognition
of a business combination).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets are recognized for all temporary differences that are tax deductible, up to
the amount of the differences that are expected to be utilized in the future, against
taxable income.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the main types of differences, in respect of which deferred taxes have been included
 see note 12b.
| | ----------------------------------------------------------------------------------------------------------

| | 3) | Deferred
tax balances are computed at the tax rates expected to be in effect at           the time
the deferred tax asset is utilized or the deferred tax liability is           settled,
based on the tax rates and the tax laws enacted, or substantively           enacted, by
the balance sheet date.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | The
current taxes, as well as the changes in the deferred tax balances are
               included in the tax expenses or income in the reporting period, except for
taxes                derived from the initial recognition of business combinations and
except for the                tax in respect of transactions that are recognized directly
in                shareholders equity (in such instances, the applicable tax is
taken                directly to shareholders equity).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) | Taxes
that would apply in the event of disposal of investments in investee           companies
have not been taken into account in computing the deferred taxes, as           it is the
Companys policy to hold these investments, not to realize them.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | m. | Revenue
recognition
| | -- | -------------------

| | Revenues
from sales are recognized upon delivery of goods to the customer. Discounts, including
those relating to gift certificates, are recognized as a reduction of sales upon
occurrence of the related sales.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
from sale of gift certificates is deferred and is recognized as income only when the gift
certificate is redeemed for active goods, or when there is only a remote likelihood that
the customer will require that the Company fulfills its performance obligations, based on
the Companys experience.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | n. | Club
member awards
| | -- | ------------------

| | Club
members participating in the Companys programs are entitled to earn points 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 value of such points, adjusted for points that are estimated to expire
without utilization, is charged to cost of sales or selling expenses, according to their
nature, in the period in which the points are earned by the club members.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o. | Rebates
from suppliers
| | -- | ----------------------

| | Current
rebates from suppliers are recorded in the financial statements upon receipt.
| | -------------------------------------------------------------------------------------

| | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
some cases, 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, provided it is probable that the final
target will be met and the total rebate can be reliably estimated. Estimates as to
whether the final target will be met are based, among others, on past experience, the
Companys relationship with the supplier, and the amount of the anticipated
purchases for the remaining period. Rebates from suppliers are presented as a reduction
of inventories and cost of sales, as applicable.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. | Convenience
translation into U.S. dollars
| | -- | -----------------------------------------

| | The
financial statements as of December 31, 2005 and for the year then ended have been
translated into U.S. dollars at the representative rate of exchange on December 31, 2005
(U.S. $ 1 = NIS 4.603). The translation was made solely for the convenience of
the reader.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
U.S. dollar amounts presented in these financial statements should not be construed to
represent amounts receivable or payable in dollars or convertible into dollars, unless
otherwise indicated.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. | Advertising
costs
| | -- | -----------------

| | Advertising
costs are expensed as incurred. Reimbursements from suppliers in respect of specific
joint advertising campaigns are recognized in accordance with EITF 02-16 Accounting
by a Customer (including a Reseller) for Certain Consideration Received from a Vendor,
as a reduction of these costs, when incurred.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | r. | Store
closure costs
| | -- | -------------------

| | A
liability for costs to terminate a lease contract before the end of its term is
recognized and measured at its fair value when the Company terminates the contract. A
liability for costs that will continue to be incurred under the contract for its
remaining term, when the Company ceases the use of the leasehold, and which have no
economic benefits for the Company, is recognized and measured at its fair value when the
Company ceases using the leasehold. Leasehold improvements are written off at such time.
Other costs are expensed as incurred.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | s. | Dividend
declared subsequent to balance sheet date
| | -- | --------------------------------------------------

| | Liabilities
relating to dividends declared subsequent to balance sheet date are included in the
accounts for the period in which the declaration was made. The amount declared is
appropriated, however, from retained earnings, and reported as a separate item in the
statement of shareholders equity under  dividend declared subsequent to
balance sheet date.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | t. | Earnings
(loss) per share (EPS)
| | -- | ---------------------------------

| | EPS
is computed in accordance with guidelines prescribed in Opinion No. 55 of the Israeli
Institute. Basic EPS is computed on the basis of the weighted average of the paid-up
share capital outstanding during the year, assuming conversion of convertible securities
as of the later of the beginning of the year or the date of issuance, if such conversion
is probable. Diluted EPS is computed as stated above, plus the effect of the assumed
conversion of those convertible securities not included in the computation of basic EPS.
If the effect of the assumed conversion of convertible securities is anti-dilutive, they
are not included in the computation. In 2005 and 2004 the dilution effect of the assumed
conversion of convertible securities was immaterial.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | u. | Linked
balances and balances in foreign currency
| | -- | ------------------------------------------------

| | Balances
in or linked to foreign currency are presented in the financial statements at the
representative exchange rates prevailing on balance sheet date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | Balances
linked to the Israeli CPI are based on the appropriate index for each linked asset or
liability.
| | ---------------------------------------------------------------------------------------------------------

| | v. | Derivatives
| | -- | -----------

| | Gains
and losses on derivatives that are hedging existing assets or liabilities are recognized
in statements of operations commensurate with the results from those assets or
liabilities.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Until
September 2005, the Company declared dividend in dollars. The Company entered into
forward exchange contracts in order to hedge the amount of dividend paid from changes in
the exchange rate of the dollar. Gains and losses on such derivatives were carried to the
amount of dividend paid.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | w. | Recently
issued accounting pronouncements in Israel:
| | -- | ----------------------------------------------------

| | 1. | In
August 2005, the IASB issued Israel Accounting Standard No. 22           Financial
Instruments: Disclosure and Presentation, which is based           on International
Accounting Standard No. 32. This standard prescribes the rules           for the
presentation of financial instruments and the proper disclosure required
          therefore. The standard prescribes the rules pursuant to which financial
          instruments are to be classified and are to be presented as a liability (while
          broadening the definition of a financial liability) or as an equity instrument
          (presented within shareholders equity). The standard also prescribes
rules           for bifurcating and classifying compound financial instruments (that
include           both an equity component and a liability component), the circumstances
under           which the offsetting of financial assets and financial liabilities is
permitted,           and the treatment of the costs of issuing financial instruments. The
standard           also prescribes that interest, dividends, losses and gains relating to
financial           instruments shall be recorded as income or expense in the income
statements when           the instrument is classified as a financial liability, or as an
equity movement           when the instrument is classified as an equity instrument.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
accounting standard is to be applied to financial statements for periods commencing on or
after January 1, 2006, and is to be applied prospectively. Upon initial implementation of
the standard, all the financial instruments existing at the transition date will be
classified and presented in accordance with the classification and presentation rules
prescribed by the said standard; compound financial instruments will be bifurcated into
their components, prior to said classification, in accordance with the transitional
provisions prescribed by the said standard. Comparative data will not be restated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | When
the standard takes effect, the Israeli Institutes Opinion 48  Accounting
Treatment of Option Warrants, and Opinion 53  Accounting Treatment of
Convertible Liabilities will be revoked.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
provisions of this standard differ from current Israeli principles and practice with
regard to the accounting treatment of certain financial instruments. Accordingly, its
adoption is likely to have effects on the companys assets, liabilities and
shareholders equity and also on the reported results in future periods, primarily
regarding the following matters:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
the revocation of Opinion 53, convertible debentures will be bifurcated into their
component parts on January 1, 2006; on the said date, the liability component will be
classified and presented, net of related deferred issuance costs (see below), among the
groups liabilities, while the equity component, will be classified and presented,
net of related deferred issuance costs (see below), as part of the shareholdersequity.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | The
balance of deferred issuance costs related to the convertible debentures, which at
December 31, 2005, amounted to approximately NIS 850 thousands will be bifurcated at
the time of the standard taking effect into components related to the equity component
and to the liability component of the debentures. The component of deferred issuance
costs, related to the equity component of the debentures, will be netted from the
debentures equity component classified as part of the shareholders equity,
whereas the component of deferred issuance costs, related to the liability component of
the debentures, will be presented as a deduction from the amount of the liability to
which such costs relate and amortized in future reporting periods according to the
interest method. Such expenses are currently amortized over the term of the debentures,
in proportion to their outstanding balance. The change in the method of their
amortization will not have a material effect on operating results in future reporting
periods.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of deferred issuance costs related to the Companys non-convertible
debentures which at December 31, 2005, amounted to approximately NIS 777 thousands, will
be presented as a deduction from the amount of the liability to which such costs relate
and amortized in future reporting periods according to the interest method. Such expenses
are currently amortized over the term of the debentures, in proportion to their
outstanding balance. The Company is currently assessing the effect of bifurcating the
equity component as explained above.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
September 2005, the IASB issued Accounting Standard Israel No. 24            Share-based
Payment. This standard prescribes the recognition           and measurement
principles, as well as the disclosure requirements, relating to           share-based
payment transactions. Prior to the issuance of said standard, no           mandatory
directives were in place in Israel for the measurement and recognition           of
share-based payment transactions, with the exception of certain disclosure
          requirements.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
new standard is applicable to transactions whereunder the company acquires goods or
receives services in consideration for equity instruments of the company (hereafter -
equity grant), or cash (or other assets) consideration, where the amount of the
consideration is based on the price or value of equity instruments of the company
(hereafter - liability grant). The standard requires the recognition of such
transactions at fair value. The standard is applicable to share-based payment
transactions with employees and non-employees.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | With
respect to equity grants to employees, the standard stipulates that the value of the
labor services received from them in return is to be measured on the day of the grant,
based on the fair value of the equity instruments that were granted to the employees. The
value of the transactions, measured in the above manner, is to be expensed over the
period that the employees right to exercise or receive the underlying equity
instruments vests; commensurate with the recognition of the expense, a corresponding
increase is to be recorded as a capital surplus under the companys shareholders equity.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the standard, the initial measurement of the fair value of liability
grants is to be made on the date of the grant and recognized as a liability in the companys
balance sheet; thereafter, the liability is to be remeasured at each balance sheet date
until said liability is settled. The changes in the amount of the liability are carried
to the income statement on a current basis. The standard also sets out guidelines for the
allocation of income taxes in respect of share-based payments.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accounting
Standard No. 24 is to be applied to financial statements covering periods commencing on,
or after, January 1, 2006. Early adoption of the standard is encouraged.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
the Company has no current employee or non-employee compensation plans, implementation of
the standard will have no effect on its financial statements. Nevertheless, prospective
new grants of options or shares to employees or service providers of the Company shall
result, in the following reporting periods, in the recording of payroll expenses or
expenses relating to the cost of the services, at their fair value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | In
February 2006, the IASB issued Israel Accounting Standard No. 21           Earnings
per Share, which is based on International Accounting           Standard No. 33.
Accounting Standard No. 21 provides rules for the           computation of earnings
per share data and their presentation in the financial           statements, and is to
supersede, starting from its effective date, the existing           rules relating to the
computation and presentation of such data, which are based           on Opinion 55
of the Israeli Institute; the standard is to be applied in           financial statements
for periods commencing on or after January 1, 2006.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the standard, the computation of basic earnings per share is generally based on the
earnings available for distribution to holders of ordinary shares, which is divided by
the weighted average number of ordinary shares outstanding during the period. This
computation no longer takes into account the effect relating to potential shares that may
derive from the expected conversion of convertible financial instruments, or the
performance of contracts that confer rights to shares upon their holders.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | In
computing the diluted earnings or loss per share, the weighted average number of shares
to be issued is to be added to the average number of ordinary shares used in the
computation of the basic earnings per share data, assuming that all dilutive potential
shares will be converted into shares. The potential shares are taken into account, as
above, only when their effect is dilutive (reducing the earnings or increasing the loss
per share from continuing activities); for the purpose of the computation of the weighted average,
dilutive potential ordinary shares shall be deemed to have been converted into ordinary
shares at the beginning of the period or, if later, the date of the issue of the potential
ordinary shares. The standard also revises the treatment of the effect on the earnings
resulting from the expected conversion of potential shares, and makes certain adjustments
to the the companys share in the operating results of associated companies and
consolidated subsidiaries for the purpose of their inclusion in earnings used for the
computation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
the initial adoption of the standard, and in accordance with the transitional provisions
stipulated therein, the comparative earnings per share data are to be restated in the
financial statements, in order to reflect, with retroactive effect, the computation of
the earnings per share under the new directives.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | In
February 2006, the IASB issued Israel Accounting Standard No. 25           Revenue,
which is based on International Accounting Standard           No. 18. This standard
prescribes recognition, measurement, presentation and           disclosure criteria for
revenues originating from the sale of goods purchased or           manufactured by the
company, the provision of services, as well as revenues           deriving from the use
of the companys assets by others (interest income,           royalties or
dividends).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
principal issue in accounting for revenue is determining the timing of revenue
recognition. Revenue from the sale of goods shall be recognized when all the following
conditions have been satisfied: (a) the significant risks and rewards of ownership of the
goods have been transferred to the buyer; (b) the company retains neither continuing
managerial involvement to the degree usually associated with ownership nor effective
control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it
is probable that the economic benefits associated with the transaction will flow to the
company; and (e) the costs incurred or to be incurred in respect of the transaction can
be measured reliably.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
clarification of said standard was issued by the IASB in February 2006: Clarification No. 8
 Reporting of Revenue on a Gross or Net Basis. According to the
clarification, a company acting as an agent or an intermediary without bearing the risks
and rewards resulting from the transaction, will present its revenue on a net basis (as
profit or commission). However, a company that acts as a principal supplier and bears the
risks and rewards resulting from the transaction will present its revenue on a gross
basis, distinguishing the turnover from the related expenses.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Standard
25 shall be applicable to financial statements for periods commencing on or after January 1,
2006. The standard is to be applied prospectively; nevertheless, in accordance with the
transitional provisions of the standard, the classification and presentation of revenue
on a gross or net basis, as above, shall be applied with retroactive effect, including
the restatement of revenues and expenses appearing in the comparative figures in the
financial statements for periods commencing on the effective date of the standard.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES(continued):
|------ | - | -------------------------------------------

| | Until
the publication of the said standard and the related clarification, there were no
accounting pronouncements in Israel concerning revenue, and the accounting treatment of
this issue was mostly based on generally accepted accounting practices and foreign
accounting pronouncements.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Implementation
of the standard commencing January 1, 2006, required the financing component, contained
in a credit sale, to be separated (by discounting the future cash inflows), except in the
case of sales made on short term credit, where the effect of discounting the proceeds
thereof would not be material.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently assessing the significance of the financing component in its credit
sales.
| | ---------------------------------------------------------------------------------------------------

| | 5) | In
March 2006, the IASB issued Israel Accounting Standard No. 20           The
Accounting Treatment of the Goodwill and Intangible Assets of Investee           Companies.
According to this standard, as of January 1, 2006, the           amortization of
goodwill and other intangible assets with indefinite useful           lives is to be
discontinued; in the future, such assets would be subject to an           impairment
test, which is to be performed at least once a year, or more           frequently, in the
presence of events or circumstances indicating a possible           impairment in the
value of such assets.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3 |  | INVESTEE
COMPANIES:
|------ | - | -------------------

| | a. | Subsidiary
consolidated for the first time:
| | -- | -------------------------------------------

| | In
May, 2005, the Company completed the purchase of 50% of the holding of Hamachsan
Hamerkazi Kfar Hashaashuim Ltd (Kfar Hashaashuim), an Israeli
company that operates non-food chain stores through franchises. The acquisition cost of
the company was allocated to the assets and liabilities of the acquired company based on
their fair values on the date of acquisition and the balance, in an amount of NIS 12.3
million, was allocated to goodwill which is amortized at the rate of 10% per annum.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the purchase agreement, the Company controls the board of directors of Kfar Hashaashuin.
The other 50% shareholders have only protective rights under the agreements as defined in
interpretation No.5 of the IASB. Accordingly, the Company consolidates the financial
statements of Kfar Hashaashuim as from June 30, 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
consolidated statements of operations for the year 2005 includes the share in the profits
of Kfar Hashaashuim for the period from July 1, 2005 to December 31, 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total acquisition price in the amount of NIS 25 million consists of payment of NIS 3.2
million for the shares and NIS 21.8 million, which was granted as a shareholder loan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 3 |  | INVESTEE
COMPANIES(continued):
|------ | - | ------------------------------

| | Concurrent
with the issuance of the shareholder loan, on May 30, 2005 Kfar Hashaashuim issued
capital notes in a total amount of NIS 21.8 million in respect of the shareholders loan.
The capital notes are unlinked and interest free. No repayment date has been fixed, but
the Company and Kfar Hashaashuim do not intend the notes to be repaid before June
1, 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
purchase agreement determined that the shareholders loan repayment will be comprised of
distributable earnings but not in excess of 50% of such earnings and that the other
shareholders in Kfar Hashaashuim will be entitled consequently to a preferred
dividend in amount equal to the loan repayment on such date, up to the full repayment of
the loan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
are data relating to the abovementioned company included in the consolidated financial
statements as of December 31, 2005:
| | ------------------------------------------------------------------------------------------------------------------------------------

| |                                               | NIS in thousands
| | --------------------------------------------- | ----------------
|
|
|
|
| | Balance sheet:                                |                 
| | Current assets                                |                 
| | Fixed assets, net of accumulated depreciation |                 
| | Goodwill                                      |                 
| | Deferred income taxes                         |                 
| | Long term receivables                         |                 
| | Current liabilities                           |                 
| | Long-term liabilities                         |                 
| | Minority interest*                            |                 
| |                                               |                 
| |                                               |                 
| |                                               |                 

| | * | including
NIS 10.9 million which represent the minority interest in preferred dividends as
explained above.
| | - | -----------------------------------------------------------------------------------------------------------

| |                               | For the period
from July 1 to December 
31, 2005
| | ----------------------------- | ------------------------------------------------
|
|
|
|
| | Statements of operations:     |                                                 
| |                               |                                                 
| | Sales                         |                                                 
| |                               |                                                 
| | Cost of sales                 |                                                 
| |                               |                                                 
| | Income before taxes on income |                                                 
| |                               |                                                 
| | Income after taxes on income  |                                                 
| |                               |                                                 
| | Minority interest in profits  |                                                 
| |                               |                                                 

F - 24

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 3 |  | INVESTEE
COMPANIES(continued):
|------ | - | ------------------------------

| | b. | Investment
in an associated company:
| | -- | ------------------------------------

| | 1) | Composition:
| | -- | ------------

| |                                                  | December 31,
| | ------------------------------------------------ | ------------
|
|
|
|
| | Shares:                                          |             
| |                                                  |             
| | Cost of shares                                   |             
| | Share in undistributed profits accumulated since |             
| | acquisition                                      |             
| |                                                  |             
| |                                                  |             
| | Perpetual capital notes (a)                      |             
| | Long-term loans (b)                              |             
| |                                                  |             
| |                                                  |             
| |                                                  |             

| | (a) | Perpetual
capital notes are linked to the Israeli CPI and bear interest at an           annual rate
of 5%.
| | --- | ----------------------------------------------------------------------------------------------------------

| | (b) | The
loans are linked to the Israeli CPI and bear interest at an annual rate of           5%.
The repayment date has not yet been determined.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Change
during the year
| | -- | ----------------------

| |                                    | NIS in
thousands
| | ---------------------------------- | ----------------
|
|
|
|
| | Balance as of January 1, 2005      |                 
| |                                    |                 
| | Share in undistributed profits     |                 
| | Changes in perpetual capital notes |                 
| |                                    |                 
| |                                    |                 
| | Balance as of December 31, 2005    |                 
| |                                    |                 

| | 3) | As
to commitment to acquire an associated company, see note 9(b)1.
| | -- | ------------------------------------------------------------------

F - 25

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 3 |  | INVESTEE
COMPANIES(continued):
|------ | - | ------------------------------

| | c. | Proportionately
consolidated companies:
| | -- | ---------------------------------------

| | Following
are data of the jointly controlled entities (see list in appendix 2)  on the
basis of the Companys percentage of holding (50%)  as reflected in the
Companys consolidated financial statements:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1) | Balance
sheet data:
| | -- | -------------------

| |                       | December 31,
| | --------------------- | ------------
|
|
|
|
| | Current assets        |             
| | Non-current assets    |             
| | Current liabilities   |             
| | Long-term liabilities |             

| | 2) | Operating
results data:
| | -- | -----------------------

| |                    | 2003 | * 2004 | 2005
| | ------------------ | ---- | ------ | ----
|
|
|
|
| | Revenues           |      |        |     
| | Costs and expenses |      |        |     
| | Net income (loss)  |      |        |     

| | 3) | Cash
flows data:
| | -- | ----------------

| |                                                     | 2003 | * 2004 | 2005
| | --------------------------------------------------- | ---- | ------ | ----
|
|
|
|
| | Net cash provided by operating activities           |      |        |     
| | Net cash used in financing activities               |      |        |     
| | Net cash provided by (used in) investing activities |      |        |     

| | * | In
May 2004, BSIP completed the purchase of the remaining 50% of a former investee company
(hereafter  Teco) share capital. Management decided that in the event it does not
succeed to realize the investment in Teco by way of sale, it will act to discontinue Tecos
operation in the near future. Consequently the Company discontinued Tecos
proportional consolidation as from the second quarter of 2004. The investment balance in
Teco in the amount of NIS 386 thousands was presented under Other accounts
receivable.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June, 2005, BSIP signed an agreement for the sale of its entire holdings in Teco
(including shareholders loans). Pursuant to this agreement, BSIP received approximately
NIS 13.8 million in consideration for the sale of its holdings in Teco, and for BSIPs
assuming Tecos bank loans and other liabilities that amounted to approximately NIS
11 million.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 3 |  | INVESTEE
COMPANIES(continued):
|------ | - | ------------------------------

| | As
a result of the aforesaid, the Company has included a gain of approximately NIS 2.3
million within other income.
| | ---------------------------------------------------------------------------------------------------------------------

| | d. | Acquisition
of partners interest in partnership
| | -- | ------------------------------------------------

| | In
November 2002, a subsidiary entered into an agreement with the partner of the Jerusalem
Malha Shopping Center Partnership for the purchase of the partners 50% share in the
partnership (the remaining 50% is held by the subsidiary) in consideration for
approximately NIS 6,854 thousands. Implementation of the agreement was subject to the
approval of the Director of the Antitrust Authority, which was obtained in March 2003.
The goodwill arising from the above acquisition amounted to NIS 4.1 million.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 4 |  | FIXED
ASSETS:
|------ | - | -------------

| | a. | Composition
of assets and the accumulated depreciation and amortization           thereon, grouped by
major classifications, and changes therein in 2005, are as           follows:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | Land and
buildings
including
leasehold
land (1) | Leasehold
improvements | Furniture,
equipment
and
installations | Motor
vehicles | Total
| | ------------------------------- | ----------------------------------------------- | ---------------------- | -------------------------------------- | -------------- | -----
|
|
|
|
| | Cost:                           |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at January 1, 2005      |                                                 |                        | *)                                     | 1,806,865      |      
| | Additions                       |                                                 |                        |                                        | 2,179          |      
| | Disposals                       |                                                 |                        |                                        | (639           | )    
| | Changes due to acquisition of a |                                                 |                       
| | subsidiary consolidated for     |                                                 |                       
| | the first time                  |                                                 |                        |                                        | -              |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at December 31, 2005    |                                                 |                        |                                        | 1,808,405      |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Accumulated depreciation and    |                                                 |                       
| | amortization:                   |                                                 |                       
| |                                 |                                                 |                       
| | Balance at January 1, 2005      |                                                 |                        | *)                                     | 263,480        |      
| | Additions                       |                                                 |                        |                                        | 24,668         |      
| | Eliminated on disposals         |                                                 |                        |                                        | (296           | )    
| | Changes due to acquisition of a |                                                 |                       
| | subsidiary consolidated for     |                                                 |                       
| | the first time                  |                                                 |                        |                                        | -              |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at December 31, 2005    |                                                 |                        |                                        | 287,852        |      
| |                                 |                                                 |                        |                                        |                |      
| | Impairment of fixed assets (see |                                                 |                       
| | b below)                        |                                                 |                        |                                        | (84,132        | )    
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Net book value at December 31,  |                                                 |                       
| | 2005                            |                                                 |                        |                                        | 1,436,421      |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Net book value at December 31,  |                                                 |                       
| | 2004                            |                                                 |                        | *)                                     | 1,454,680      |      
| |                                 |                                                 |                        |                                        |                |      

| | *) | Reclassified
| | -- | ------------

| | (1) | Certain
real estate assets which had been transferred to the Company from the
               previous parent cooperative are in the process of being registered under
the                name of the Company.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 4 |  | FIXED
ASSETS(continued):
|------ | - | ------------------------

| | b. | During
2003, due to, among others, the closure of stores (see note 15j) and the
          continuing economic slowdown, the Company recorded a net loss from impairment
of           assets of approximately NIS 41.6 million. This impairment loss is net of a
          reduction of the impairment provision, recorded during 2002, in the approximate
          amount of NIS 21 million. The change in the impairment provision in 2003
          reflects updated operating and forecasted results of the Companys
          management regarding various assets.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2004, the Company has recorded an impairment loss provision of NIS 5.5 million (see note
15j). This impairment loss is net of a reduction of the impairment provision, recorded
during 2003 and 2002, in the approximate amount of NIS 27.6 million. The reduction of the
impairment provision in 2004 was due to improvement in results relating to certain stores.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Impairment
loss is included in other (income) expenses, net, see note 15j.
| | --------------------------------------------------------------------------

| | During
2005 the Company recorded a reduction of the impairment provisions in the net amount of
NIS 0.1 million. This was the result of recording provision of NIS 15.5 million for the
first time in respect of certain stores, against which was offset the reduction in the
impairment provision in respect of other stores that had been recorded in previous years
in the amount of NIS 15.6 million.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
calculating the impairment for the reported periods, based on discounted expected future
cash flows, the Company used a discount rate of 8% (before tax), which was determined, by
an independent expert.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of the provision for impairment as of December 31, 2005 and 2004, 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 year.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Additional
details:
| | -- | -------------------

| | 1) | Composition
of net book value of land and buildings as of December 31, 2005:
| | -- | ----------------------------------------------------------------------------

| |                                                                  | NIS
| | ---------------------------------------------------------------- | ---
|
|
|
|
| | Ownership                                                        |    
| |                                                                  |    
| | Capitalized leaseholding from the Israel Land Administration for |    
| | periods ending 2020-2080 (including the option period which is   |    
| | relevant for some of the lands)                                  |    
| |                                                                  |    
| |                                                                  |    
| |                                                                  |    

| | 2) | Part
of the ownership rights and leasehold rights have not been technically
               recorded in the name of the companies.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

| | d. | As
to liens placed on assets, see note 11.
| | -- | ------------------------------------------

F - 28

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 5 |  | OTHER
ASSETS:
|------ | - | -------------

| |                                      | December 31,
| | ------------------------------------ | ------------
|
|
|
|
| | Goodwill                             |             
| |                                      |             
| | Deferred changes:                    |             
| | Debenture issuance expenses          |             
| | Prepaid rental expenses and          |             
| | acquisition tax                      |             
| |                                      |             
| |                                      |             
| |                                      |             
| |                                      |             
| | Deferred income taxes (see note 12b) |             
| |                                      |             
| |                                      |             
| |                                      |             

|NOTE 6 |  | LONG
-TERM LOANS FROM BANKS:
|------ | - | ----------------------------

| | a. | Composition:
| | -- | ------------

| |                               | Annual
interest
rate | December 31,
| | ----------------------------- | -------------------- | ------------
|
|
|
|
| | In foreign currency-          |                      |             
| | Swiss Frank                   |                      |             
| | In Israeli currency:          |                      |             
| | Linked to the Israeli CPI (3) |                      |             
| | Unlinked (2)                  |                      |             
| |                               |                      |             
| |                               |                      |             
| |                               |                      |             
| | Less - current maturities     |                      |             
| |                               |                      |             
| |                               |                      |             
| |                               |                      |             

| | (1) | Weighted
average rate as of December 31, 2005.
| | --- | ----------------------------------------------

| | (2) | As
of December 31, 2005 includes approximately NIS 650 million at variable
               interest (average annual rate as of December 31, 2005  5.0%, for the
major                part of these loans, based on PRIME minus 1.12%). The balance of
approximately                NIS 35 million is at a fixed annual interest rate of 6.67%.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | The
Company entered into Israels CPIs swap contracts in respect of
               long term loans. The loss in 2005 amounting to NIS 1,273 thousands was
               recognized in the statements of operations.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005 the company had no outstanding balance related to the above swap
contracts.
| | ---------------------------------------------------------------------------------------------------

F - 29

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 6 |  | LONG
-TERM LOANS FROM BANKS(continued):
|------ | - | ---------------------------------------

| | (4) | Including
loan in the amount of NIS 500 million which was taken in connection                with
the real estate reorganization, see note 9b (2).
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------

| | The
loan bears variable interest on the basis of PRIME minus 1.12% (the PRIME at December 31,
2005  6%) and the principal and the interest repayable in one payment on January
29, 2007. The loan is secured by a restricted bank deposit.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
long-term loans are repayable in the years subsequent to the balance sheet           date
as follows:
| | -- | ---------------------------------------------------------------------------------------------------------

| |                                 | December 31
| | ------------------------------- | -----------
|
|
|
|
| | First year - current maturities |            
| | Second year                     |            
| | Third year                      |            
| | Fourth year                     |            
| | Fifth year                      |            
| | Sixth year and thereafter       |            
| |                                 |            
| |                                 |            
| |                                 |            

| | c. | As
to collateral with respect to long-term loans  see note 11(c).
| | -- | ------------------------------------------------------------------

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES:
|------ | - | --------------------------------------

| | a. | In
August 2003, the Company issued to institutional investors NIS 400 million           par
value debentures 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 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. 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 semiannually 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
one third of the par value of the debentures outstanding as of December 31, 2005 was
classified as current liabilities.
| | ------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES(continued):
|------ | - | -------------------------------------------------

| | (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 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. 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 semiannually 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, 2005 the conversion ratio
is that each NIS 32.89 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 10(b)).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2005, Company debentures with a par value of approximately NIS 5,517 thousand were
converted into 167,755 ordinary shares.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | b. | 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 Maalot The Israeli Securities Rating
Company Ltd.                (Maalot) reduces the Companys rating to BBB
or lower, then                within three months from one of the abovementioned 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.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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 will be less than 3.5,
and           for the period from the aforementioned date, the ratio will be less than 3.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES(continued):
|------ | - | -------------------------------------------------

| | b) | The
ratio between the carrying amount of fixed assets 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, 2005, the Company meets the aforementioned financial covenants.
| | ----------------------------------------------------------------------------------

| | c. | As
to the changes in the presentation of debentures, commencing January 1, 2006
          see also note 2w(1).
| | -- | --------------------------------------------------------------------------------------------------------------

|NOTE 8 |  | LIABILITY
FOR EMPLYEE RIGHTS NET OF AMOUNT FUNDED:
|------ | - | --------------------------------------------------

| | a. | Severance
pay
| | -- | -------------

| | Substantially
all Company employees have joined comprehensive pension or management insurance plans.
The payments to the pension funds and insurance companies fulfill the Companys
obligation to employees as required by the Severance Pay Law. Accumulated amounts in the
pension funds and with the insurance companies are not under the control or
administration of the Company, and accordingly, neither those amounts nor the
corresponding accrual for severance pay are reflected in the balance sheet. The
obligation of the Company, under law and labor agreements, for termination benefits to
employees not covered by the aforementioned pension or insurance plans is included in the
balance sheet.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Amounts
deposited with severance pay funds include profits accumulated to balance sheet date. The
amounts deposited may be withdrawn only after fulfillment of the obligations under the
Severance Pay Law and labor agreements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Compensation
for unutilized sick leave
| | -- | --------------------------------------

| | Pursuant
to agreements signed between the Company and its employees, the employees are entitled
each year to 30 days of sick leave, the rights to which accumulate under certain
conditions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
accrual for unutilized sick leave included in the financial statements is based on an
independent actuarial calculation (which takes into account estimated employee turnover,
future wage levels, etc.)
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | The
balance sheet liability for employee rights upon retirement, and the amount
          funded with severance pay funds, are composed as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |                                               | December 31,
| | --------------------------------------------- | ------------
|
|
|
|
| | Accrued severance pay                         |             
| | Less - amounts funded                         |             
| |                                               |             
| |                                               |             
| |                                               |             
| | Provision in respect of unutilized sick leave |             
| |                                               |             
| |                                               |             
| |                                               |             
| |                                               |             

F - 32

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 8 |  | LIABILITY
FOR EMPLYEE RIGHTS NET OF AMOUNT FUNDED(continued):
|------ | - | -------------------------------------------------------------

| | The
Company may only make withdrawals from the severance pay funds for the purpose of paying
severance pay.
| | -----------------------------------------------------------------------------------------------------------

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS:
|------ | - | --------------------------------------

| | a) | Contingent
liabilities:
| | -- | -----------------------

| | 1. | On
April 17, 1999, an inquiry was conducted at the Companys offices by
          representatives of the Antitrust Authority. To the best of the Companys
          knowledge, the inquiry was conducted in connection with an investigation of a
          suspicion of restrictive trade arrangements between major supermarket chains
and           the large suppliers. In addition, the Companys former CEO and other
senior           officers of the Company were investigated.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
January 5, 2005, the Director of the Antitrust Authority (the Director)
published the findings of the investigation and the final position of the Antitrust
Authority, following his examination of all the arguments brought before him.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
this report, the Director stated his position regarding the fact that there were
restrictive trade practices that pose a real threat to competition and that such
practices should be discontinued, except where approved by the Restrictive Trade
Practices Court or where exempted by the Director himself.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Further
to the above, the Director of the Antitrust Authority has decided to take the following
operative measures in order to enforce the law:
| | -----------------------------------------------------------------------------------------------------------------------------------------------

| | a. | 1) | The legal department of the Antitrust Authority shall bring legal           proceedings
against anyone who is a party to clear breaches of the law.
| | -- | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Should
it prove necessary, prospective legal measures such as injunctions and           issuing
directives to monopoly holders will be taken.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
suppliers and the chains involved shall be ordered to present the agreement           and
arrangements they have made with each other in relation to 2004, in order to
          ensure that the prohibited practices have ceased and that the recommendation of
          the Director have been implemented.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | All
the agreements between the dominant suppliers and the other supermarkets           (that
are not among the major food chains) will also be examined.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------

| | Among
the matters covered within the framework of the directives issued by the Director of the
Antitrust Authority, the Director has determined that: arrangements that determine the
suppliers, 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 shares and charges made by the chains in
respect of local competition, are restrictive practices.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | With
regard to display areas, financial benefits to the chains and special offers  limits
have been prescribed.
| | ----------------------------------------------------------------------------------------------------------------

F - 33

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS(continued):
|------ | - | -------------------------------------------------

| | Regarding
the use of suppliers staff to stock merchandise on the shelves of the chainsstores,
the Director has expressed his opinion that such existing practices fall within the
definition of a restrictive trade practice. Accordingly, a six-month reorganization
period has been set for the discontinuance of such practices or for obtaining appropriate
approvals.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Director has permitted the exchange of information, so long as this is done on a
transparent and equal basis.
| | -----------------------------------------------------------------------------------------------------------------

| | The
Director findings do not refer specifically to the Company.
| | ---------------------------------------------------------------

| | On
December, 2005, the Director issued a draft of an agreed-upon order, which it is his
intention to submit to the Anti-Trust Tribunal for approval under Section 50B of the
Trade Restrictions Law. The agreed-upon draft is directed at the food suppliers listed
therein and stipulates various prohibitions, conditions and restrictions that shall apply
to these suppliers with regard to certain practices. Among the matters covered, the order
determines arrangements regarding: (1) limiting the number of suppliers; (2) purchasing
shelf and non-shelf display space; (3) category management; (4) shelf stacking; (5)
bonuses and benefits for achieving sale targets; (6) determining market share; (7)
exclusivity of sale promotions; (8) pricing dictated by suppliers.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
draft of the order clarifies that there is nothing in the provisions contained therein to
prevent the chain from allocating shelf space at its own 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | While
the Company is not a party to the agreed-upon order, said order could nevertheless have
an effect on its suppliers dealings with it.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has been applying most of these directives for some time already, inter alia by
means of an internal enforcement program that was adopted by the Company. This
notwithstanding, the Company is reviewing the Directors directives and shall act in
accordance with a legal opinion thereon that is to be obtained.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2002, the director announced that the arrangements relating to the gift
          certificates issued by the company and other supermarkets chains apparently
          constitute a restrictive arrangement pursuant to the antitrust law.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
cannot presently determine the impact, if any, of the aforementioned announcement on the
Companys business. Following the announcement, the Company ceased issuing the gift
certificates jointly with other chains and is presently issuing its own gift certificates.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 34

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS(continued):
|------ | - | -------------------------------------------------

| | 3. | In
March 2003, the Antitrust Authority notified the Company that a previous
          arrangement between a subsidiary and another party with respect to a
partnership           at the Malha Shopping Center branch constitutes a restrictive
arrangement. Prior           to the aforementioned notification, the partnership was
dissolved, through the           subsidiarys acquisition of the other partys
share of the partnership           (approval for the acquisition was given by the
Director  see note 3d).           Management of the Company and its legal advisors,
are presently unable to           estimate the effect of the notification of the
Authority and its ultimate           outcome.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | In
June 2003, a petition to approve a class action suit in the aggregate amount           of
NIS 25 million was filed against the Company and certain investees in the Tel
          Aviv District Court. The petitioner is claiming damages allegedly incurred in
          respect of the unlawful rounding of amounts due from customers for products
sold           by weight in the stores of the companies.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 13, 2004 the Tel Aviv district court dismissed the request to recognize this claim
as a class action suit. Following the dismissal of the claim by the district court, the
plaintiff has appealed to the Supreme Court. After consulting its legal advisors,
management believes that there is little likelihood that the appeal will be accepted, and
accordingly, no provision with respect to this matter has been made in the financial
statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
Companys supermarkets in Israel require operating permits from local
          municipal authorities, the granting of which are conditional upon obtaining the
          prior approval of various agencies, including the Ministries of Health and
          Environment and the Police and Fire Departments. Certain of these permits were
          issued in the name of other entities other than the Company. Also, certain of
          the Companys stores have not yet been issued permits or their permits
have           expired and require renewal. In the event that the Company is unable to
obtain           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.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | In
November 2001, a claim was filed against the Company, the Company for Drink
          Containers Collection Corporation Ltd., and other supermarket chains in
          connection with fulfillment by these defendants of provisions of the Law for
          Deposits on Beverage Containers, 1999 (which became effective on October 1,
          2001). The plaintiffs have requested approval of the claim as a class action in
          the amount of approximately NIS 250 million. On January 13, 2003, the Tel Aviv
          District Court dismissed the request to recognize the said claim as a class
          action. The plaintiffs have appealed to the Supreme Court. After consulting its
          legal advisors, management believes that there is little likelihood that the
          appeal will be accepted, and accordingly, no provision with respect to this
          matter has been made in the financial statements.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS(continued):
|------ | - | -------------------------------------------------

| | 7. | Other
claims have been filed against the Company in respect of various matters           which
arose in the ordinary course of business and legal proceedings in respect
          thereof are under way. 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 the
final           outcome of these claims will not have a material adverse effect on the
          Companys results of operations or financial position.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | In
February 2004, the Company received tax assessments for the years 1999-2001,
          according to which the Company is required to pay approximately NIS 8 million.
          These assessments relate to the non-deductibility of certain expenses that were
          claimed by the Company. In April 2005, an agreement was reached with the Income
          Tax Authority with respect to most of the disputes.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | With
respect to disputes that have not yet been settled with the Income Tax Authority,
Management of the Company disagrees with the standpoint of the tax authorities and
submitted an objection to these assessments. In managements opinion, the Company
will not be required to pay material amounts, if any, in connection with these
assessments, in excess of the accruals included in the financial statements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 9. | In
July 2005, the Income Tax Authority issued 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
August 2005, the Company contested these assessments.
| | --------------------------------------------------------

| | In
November 2005, several senior employees were interrogated under warning, with respect to
these benefits.
| | -----------------------------------------------------------------------------------------------------------

| | As
of the date of approval of these financial statements, the Company is holding discussions
with the tax authorities through its advisors.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | In
the opinion of the Company and its advisors, the provisions included in the financial
statements are sufficient for covering the potential liabilities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | commitments:
| | -- | ------------

| | 1. | On
November 29, 2005, the company entered into the following agreements:
| | -- | ------------------------------------------------------------------------

| | a) | An
agreement under which the Company and Dor-Alon Energy (1988) Ltd, a company
               under common control. (Dor-Alon), will purchase from Credit
Cards                for Israel Ltd (C.A.L) 49% of a subsidiary of CAL (Diners
               Israel), for a total consideration of NIS 21.3 million (the
               consideration). 36.75% of the purchased shares will be
allocated to                the Company and 12.25% to Dor Alon. The consideration will be
funded through a                loan to be granted by CAL to the Company and Dor Alon;
the loan will be secured                by the acquired shares.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS(continued):
|------ | - | -------------------------------------------------

| | b) | An
agreement with Dor Alon establishing a joint customers club for the benefit
               of the Companys and Dor Alons customers, to be formed as a
               partnership to be held 75% by the Company and 25% by Dor Alon (the
               customer club);
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | An
agreement among the Company and Dor Alon, on one hand, and Diners Israel, on
               the other hand, pursuant to which the Customer Club will offer to members
of the                customer club a credit card issued by Diners Israel, and Diners
Israel will                provide services to the Customer Club and its members. In
addition, the                agreement contains various ancillary arrangements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | These
agreements are subject to approval by the Audit Committee, the Board of Directors and the
shareholders of the Company, the authorized bodies of Dor Alon. CAL and Discount Bank (CALs
parent company) , to the extent it is required, and the consummation of some of the
transactions contemplated by these agreements are conditioned upon the receipt of certain
regulatory approvals and third party consents. As of date of approval of these financial
statements a few approvals are yet to be received.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company intends to reorganize its real estate operations by way of           splitting
the real estate management and development activity, while           transferring the
real estate assets it owns to a new wholly-owned subsidiary           that was
established for the purpose of the split.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 30, 2005, the Company submitted to the Israeli Tax Authority, an application for
a ruling for a split under the provisions of Section 105A(2) to the Income Tax Ordinance.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
above split application relates only to assets owned by Blue Square Israel Ltd., and does
not relate to assets owned by BSIP.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | On
December 28, 2005, Blue Square received a bank loan in the amount of NIS 500
million. As of December 31, 2005, the loan monies are placed in a deposit in the amount
of NIS 500 million that is included under investment and long-term receivables. The
deposit is for a period of 13 months and bears interest at annual rate of prime minus
1.37% and is pledged in favor of the loan (see note 11(c)).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
application submitted to the Income Tax Authority also includes a request to transfer the
loan to the new company while maintaining the deposit with the parent company.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | When
the loan is transferred to the new company, subject to the consent of the Israeli Tax
Authority and the accompanying bank, other collateral for the loan will be agreed upon
with the bank.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of date of approval of the financial statements, the application has not yet been
approved by the Israeli Tax Authority.
| | ---------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS(continued):
|------ | - | -------------------------------------------------

| | 3. | Some
of the stores that are operated by the Company are leased under           non-cancelable
long-term operating leases, mostly with renewal options. Rent           expense under
these leases amounted to NIS 95 million, NIS 100 million, and           NIS 109
million for the years ended December 31, 2003, 2004 and 2005,           respectively.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Future
minimum payments under non-cancelable operating leases for the years subsequent to
December 31, 2005, are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------

| |                           | NIS
in thousands
| | ------------------------- | ----------------
|
|
|
|
| | First year                |                 
| | Second year               |                 
| | Third year                |                 
| | Fourth year               |                 
| | Fifth year                |                 
| | Sixth year and thereafter |                 
| |                           |                 
| |                           |                 
| |                           |                 
| |                           |                 

| | 4. | As
of December 31, 2005, the Company has entered into agreements for the           purchase
of equipment, in the aggregate amount of approximately NIS 8 million.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | Guarantees:
| | -- | -----------

| | 1. | As
of balance sheet date, a subsidiary granted to an associated company
               guarantees in respect of liabilities of the associated company to a third
party                in the amount of NIS 1.1 million.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company and BSIP has provided bank guarantees for a third party such as
               service suppliers and customers in an aggregate amount of approximately
NIS 4.4                million.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | The
subsidiary (Kfar Hashaashuim) and its investee companies guarantee           the
repayment of post-dated checks in the amount of NIS 2,224 thousand that were
          discounted by the bank whose date of repayment is after the balance sheet date.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 10 |  | SHARE
CAPITAL:
|------- | - | --------------

| | a. | 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, 2005 and 2004 21.6% and 21.7% of the outstanding Ordinary Shares of the
Company, respectively. As of December 31, 2005 the shares are quoted at $10.34 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, 2005 the shares are quoted at NIS 48.25 per
ordinary share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Dividends:
| | -- | ----------

| | In
January 21, 2005, the Company distributed a dividend in the amount of approximately U.S.
$ 9 million (U.S. $ 0.23 per Ordinary share or ADS) which dividend was declared in
December 26, 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2005, the Company distributed a dividend in the amount of NIS 50 million.
| | --------------------------------------------------------------------------------------

| | On
March 21, 2006, the Board of Directors declared a dividend in the amount of NIS 50
million (NIS 1.28 per share).
| | -------------------------------------------------------------------------------------------------------------------

| | As
to restriction on dividend distribution, see note7b(2).
| | ----------------------------------------------------------

| | c. | In
2004, BSIP received a court approval to reclassify to retained earnings and           to
distribute a dividend totaling NIS 80 million, from capital gains that were
          originally classified as a capital reserve, due to the accounting principles
          related to transactions between BSIP and former controlling shareholders. The
          dividend was distributed on April 11, 2005. 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.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 11 |  | LIENS:
|------- | - | ------

| | a. | As
collateral 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, 2005,           Companys
share in the balance of liabilities collateralized amounts to NIS           0.7 million.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Kfar Hashaashuim Group placed unlimited, fixed and floating charges           and a
first ranking lien in favor of its liabilities to banks amounting at           December
31, 2005, to NIS 43 million on the storehouse and all its assets,           property,
book debts, rent, goodwill, profits, revenues, rights of ownership and           other
benefits.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | To
secure a loan in the amount of NIS 500 million, the Company recorded a first
          ranking fixed charge, in an unlimited amount, on a deposit with Bank Hapoalim
          amounted to NIS 500 million, including the related interest, see also note
          9b(2).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME:
|------- | - | ----------------

| | a. | Corporate
taxation in Israel
| | -- | ----------------------------

| | 1. | Measurement
of results for tax purposes under the Income Tax (Inflationary
               Adjustments) Law, 1985 (hereafter  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 most of its subsidiaries are
taxed under this law.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 2004 and
thereafter are as follows: 2004  35%, 2005  34%, 2006  31%, 2007  29%,
2008  27%, 2009  26% and for 2010 and thereafter  25%.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of the changes in the tax rates, the Company adjusted  in each of the
years 2004 and 2005  at the time the aforementioned amendments were made, its
deferred tax balances, in accordance with the tax rates expected to be in effect in the
coming years; the effect of the change has been carried to income on a current basis.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Deferred
taxes
| | -- | --------------

| | 1. | The
composition of the deferred taxes at balance sheet dates and the changes
          therein during the years then ended, are as follows:
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------

|                                | In respect of balance sheet items |  | 
|------------------------------- | --------------------------------- |  | 
|
|
|
|
|Balance at January 1, 2004      |                                   |  | 
|Changes in 2004 -               |                                   | 
|Amounts carried to income       |                                   |  | 
|                                |                                   |  | 
|Balance at December 31, 2004    |                                   |  | 
|                                |                                   | 
|Changes in 2005:                |                                   | 
|Amounts carried to income       |                                   |  | 
|Additions of deferred taxes in  |                                   | 
|respect of company consolidated |                                   | 
|for the first time              |                                   |  | 
|                                |                                   |  | 
|Balance at December 31, 2005    |                                   |  | 
|                                |                                   |  | 

F - 40

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | 2) | Balance
of the depreciated cost of fixed assets  the portion in           respectof
which deferred taxes have not been created
| | -- | -------------------------------------------------------------------------------------------------------------------------------

| | The
balance of the depreciated cost of depreciable fixed assets includes amounts, as detailed
below, which are not recognized, for tax purposes, as depreciation or as cost at the time
of the disposal of the asset, and which are treated as permanent differences (in respect
of which deferred taxes are not to be created) in conformance with Opinion 40 of the
Israeli Institute.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | December 31
| | ------------------------------- | -----------
|
|
|
|
| | Balance as of January 1, 2005   |            
| | Depreciation during the year    |            
| |                                 |            
| | Balance as of December 31, 2005 |            
| |                                 |            

| | 3) | Deferred
taxes are presented in the balance sheets as follows:
| | -- | --------------------------------------------------------------

| |                           | December 31
| | ------------------------- | -----------
|
|
|
|
| | Other accounts receivable |            
| | Other assets              |            
| | Long-term liabilities     |            
| |                           |            
| |                           |            
| |                           |            

| | * | Realization
of this deferred tax balance is conditional upon earning, in the coming years, taxable
income in appropriate amounts.
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| | The
deferred taxes are computed at the tax rates of 25%-31%.
| | ------------------------------------------------------------

| | c. | As
of December 31, 2005 and 2004 the Company and its subsidiaries have           operating
tax loss carryforwards of approximately NIS 5.6 and NIS 54 million,
          respectively. In addition, the Company and its subsidiaries have capital loss
          tax carryforwards of approximately NIS 24 million and NIS 22 million
          respectively. The tax benefit in respect of operating tax loss carryforwards
          amounting to NIS 1.2 million and in respect of all of the capital tax loss
          carryforwards has not been recorded due to uncertainty of their realization.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | d. | Taxes
on income included in the statements of operations:
| | -- | ---------------------------------------------------------

| | 1. | As
follows:
| | -- | -----------

| |                                           | 2003 | 2004 | 2005
| | ----------------------------------------- | ---- | ---- | ----
|
|
|
|
| | In respect of the reported year:          |      |      |     
| | Current                                   |      |      |     
| | Deferred:                                 |      |     
| | In respect of changes to tax rates,       |      |     
| | See 12 a (2) above                        |      |      |     
| | In respect of the reporting period        |      |      |     
| | Tax expense (benefit) in respect of prior |      |     
| | Years:                                    |      |     
| | Current                                   |      |      |     
| | Deferred                                  |      |      |     
| |                                           |      |      |     
| |                                           |      |     
| |                                           |      |      |     
| |                                           |      |      |     

| | *) | Reclassified
| | -- | ------------

| | Current
taxes are computed in 2003 at a tax rate of 36%; in 2004  35%; in 2005-34% (see 12
a (2) above).
| | ---------------------------------------------------------------------------------------------------------

| | 2. | Following
is a reconciliation of the theoretical tax expense, assuming all                income is
taxed at the regular tax rates applicable to companies in Israel (see
               12a(2). above), and the actual tax expense:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                              | 2003 | 2004 | 2005
| | ---------------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Income before taxes on income, as reported in   the statements of operations |      |      |     
| |                                                                              |      |      |     
| | Theoretical tax expense                                                      |      |      |     
| | Increase (decrease) in taxes resulting from:                                 |      |     
| | Nondeductible amortization and impairment                                    |      |     
| | losses in respect of goodwill and fixed                                      |      |     
| | assets                                                                       |      |      |     
| | Losses for which no tax benefit has been                                     |      |     
| | recorded (utilization of tax benefits not                                    |      |     
| | previously recorded), net                                                    |      |      |     
| | Tax expense (benefit) in respect of prior years                              |      |      |     
| | Increase (decrease) in taxes resulting from                                  |      |     
| | adjustment to deferred tax balances due to                                   |      |     
| | changes in tax rates, see 12 a (2) above                                     |      |      |     
| | Nondeductible expenses and other, net                                        |      |      |     
| |                                                                              |      |      |     
| |                                                                              |      |     
| | Income tax expense                                                           |      |      |     
| |                                                                              |      |      |     

| | * | Including
decrease in taxes in the amount of NIS 2,973 thousands and NIS 172 thousand in 2004 and
2005 respectively regarding difference between the measurement of income reported for tax
purposes (which is calculated in real terms on the basis of changes in the CPI) and the
basis of measurement of income for financial reporting purposes (in nominal values,
commencing from January 1, 2004).
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 42

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | e. | Tax
assessments:
| | -- | ----------------

| | 1. | Blue
Square has received final tax assessments, or assessments deemed to be           final,
for tax years through 1998 and for 2002. Regarding tax assessments for           the
years 1999  2001, see note 9a(8).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Some
of the principal subsidiaries have received final assessments for tax years through 2001.
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 9a(9).
| | -- | -------------------------------------------------------------------

|NOTE 13 |  | LINKAGE
OF MONETARY BALANCES:
|------- | - | -----------------------------

| | a. | As
follows:
| | -- | -----------

| |                                             | December 31, 2005
| | ------------------------------------------- | -----------------
|
|
|
|
| | Current assets:                             |                  
| | Cash and cash equivalents                   |                  
| | Trade receivables                           |                  
| | Other accounts receivable                   |                  
| | Investments and long-term receivables:      |                  
| | Restricted deposit                          |                  
| | Investment in an associated company         |                  
| | Other long term receivables                 |                  
| |                                             |                  
| |                                             |                  
| |                                             |                  
| |                                             |                  
| | Current liabilities:                        |                  
| | Short-term credit from banks                |                  
| | Trade payables                              |                  
| | Other accounts payable and accrued Expenses |                  
| | Long-term liabilities (including current    |                  
| | maturities):                                |                  
| | Long-term loans from banks                  |                  
| | Debentures                                  |                  
| | Convertible debentures                      |                  
| |                                             |                  
| |                                             |                  
| |                                             |                  

F - 43

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 13 |  | LINKAGE
OF MONETARY BALANCES(continued):
|------- | - | ----------------------------------------

| | b. | Data
regarding the exchange rate and the CPI:
| | -- | ---------------------------------------------

| |                                      | Exchange rate
of one
U.S. dollar | Exchange rate
of one
Euro | CPI*        
| | ------------------------------------ | -------------------------------- | ------------------------- | ------------
|
|
|
|
| | At end of year:                      |                                  |                           |             
| | 2005                                 | NIS 4.603                        | NIS 5.447                 | 110.0 points
| | 2004                                 | NIS 4.308                        | NIS 5.877                 | 107.4 points
| | Increase (decrease) during the year:
| | 2005                                 | 6.8%                             | (7.3)%                    | 2.4%        
| | 2004                                 | (1.6)%                           | 6.2%                      | 1.1%        
| | 2003                                 | (7.6)%                           | 11.3%                     | (1.9)%      

| | * | Based
on the index for the month  ending on each  balance  sheet date,  on
                            the basis of 2000 average = 100.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

|NOTE 14 |  | FINANCIAL
INSTRUMENTS AND RISK MANAGEMENT:
|------- | - | ------------------------------------------

| | a. | Concentration
of credit risks
| | -- | -----------------------------

| | Financial
instruments that potentially subject the Company to concentrations of credit risk consist
principally of trade receivables.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | The
groups sales derive from a large number of customers and the trade receivables
consist mainly of credit card companies. Management regularly monitors the balance of
trade receivables, and the financial statements include a specific allowance computed for
accounts, the collectibility of which, in the view of management is doubtful.
Accordingly, the groups trade balances do not represent a substantial
concentrations of credit risk at December 31, 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
fair value of the financial instruments included in working capital of the Company is
usually identical or close to their carrying value. The fair value of long term
receivables and long term loans and other long term liabilities also approximates the
carrying value since they bear interest at rates close to the prevailing market rates. As
to long-term loan granted to investee company see note 3b.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION:
|------- | - | -----------------------------------------------

| | Balance
sheets:
| | ---------------

| | a. | Trade
receivables:
| | -- | ------------------

| |    |                                                       | December 31,
| | -- | ----------------------------------------------------- | ------------
|
|
|
|
| |    | Credit card receivables                               |             
| |    | Open accounts and checks receivables                  |             
| |    |                                                       |             
| |    |                                                       |             
| |    |                                                       |             
| |    | Less - allowance for doubtful accounts                |             
| |    |                                                       |             
| |    |                                                       |             
| |    |                                                       |             
| |    |                                                       |             
| | b. | Other accounts receivable:                            |             
| |    |                                                       |             
| |    |                                                       |             
| |    | Deferred income taxes (see note 12b)                  |             
| |    | Prepaid expenses                                      |             
| |    | Government agencies                                   |             
| |    | Receivables from sale of fixed assets                 |             
| |    | Investment in a former investee company (see note 3c) |             
| |    | Other                                                 |             
| |    |                                                       |             
| |    |                                                       |             
| |    |                                                       |             
| |    |                                                       |             

| | c. | Inventories:
| | -- | ------------

| |    |                                   | December 31,
| | -- | --------------------------------- | ------------
|
|
|
|
| |    | Merchandise                       |             
| |    | Parts, raw materials and supplies |             
| |    |                                   |             
| |    |                                   |             
| |    |                                   |             
| |    |                                   |             
| |    |                                   |             
| | d. | Other long-term receivables:      |             
| |    |                                   |             
| |    | Long term loans *                 |             
| |    | Checks receivables                |             
| |    |                                   |             
| |    |                                   |             
| |    |                                   |             

| | * | Including
loan granted to a third party amounting to NIS 2, 040 thousands as of December 31, 2005.
The loan bears annual interest rate of 3.57%. The principal and the interest will be paid
in 33 monthly payments until May 2008. The loan is secured by a first ranking fixed
charge on certain equipment of the third party.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | e. | Credit
and loans from banks:
| | -- | ----------------------------

| |                                       |  | 
| | ------------------------------------- |  | 
|
|
|
|
| | Short-term credit from banks          |  | 
| | Current maturities of long-term Loans |  | 
| |                                       |  | 
| |                                       |  | 
| |                                       |  | 

| | f. | Other
accounts payable and accrued expenses:
| | -- | --------------------------------------------

| |                                           |  | 
| | ----------------------------------------- |  | 
|
|
|
|
| | Payroll and related expenses and          |  | 
| | other employee benefits                   |  | 
| | Government authorities                    |  | 
| | Liability in respect of gift certificates |  | 
| | Accrued expenses and other                |  | 
| |                                           |  | 
| |                                           |  | 
| |                                           |  | 

| | g. | Minority
interest:
| | -- | ------------------

| |                                                        |  | 
| | ------------------------------------------------------ |  | 
|
|
|
|
| | Balance at beginning of period                         |  | 
| |                                                        |  | 
| | Minority interest in profits of subsidiaries, net      |  | 
| | Dividend paid to minority shareholders of subsidiaries |  | 
| | Additional minority interest related to acquisition of |  | 
| | subsidiary consolidated for the first time             |  | 
| |                                                        |  | 
| |                                                        |  | 
| | Balance at end of period                               |  | 
| |                                                        |  | 

| | Statements
of operations:
| | -------------------------

| | h. | Selling,
general and administrative expenses:
| | -- | ---------------------------------------------

| |                           | 2003 | 2004 | 2005
| | ------------------------- | ---- | ---- | ----
|
|
|
|
| | Includes advertising, net |      |      | *   
| |                           |      |      |     

| | * | Reclassified
| | - | ------------

F - 46

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | i. | Financial
expenses, net:
| | -- | ------------------------

| |    |                                                  | 2003 | 2004 | 2005
| | -- | ------------------------------------------------ | ---- | ---- | ----
|
|
|
|
| |    | In respect of:                                   |      |      |     
| |    | Long-term loans and debentures                   |      |      |     
| |    | Increase in value of marketable securities       |      |      | *   
| |    | Purchasing power gain (loss) in respect of other |      |     
| |    | monetary items                                   |      |      | *   
| |    | Interest income net of short-term credit, bank   |      |     
| |    | commissions and others                           |      |      | *   
| |    |                                                  |      |      |     
| |    |                                                  |      |     
| |    |                                                  |      |      | **  
| |    |                                                  |      |      |     
| |    | * Reclassified                                   |      |     
| |    | ** Net of borrowing costs capitalized to cost of |      |     
| |    | fixed assets                                     |      |      |     
| |    |                                                  |      |      |     
| |    |                                                  |      |     
| | j. | Other income (expenses), net:                    |      |     
| |    |                                                  |      |     
| |    |                                                  |      |     
| |    | Compensation and employee benefits (3)           |      |      |     
| |    | Termination benefits in respect of efficiency    |      |     
| |    | plan (2)                                         |      |      |     
| |    | Capital gain from sale of a former investee      |      |     
| |    | company                                          |      |      |     
| |    | Gain (loss) from sale of fixed assets, net       |      |      |     
| |    | Impairment of assets (1)(2)                      |      |      |     
| |    | Costs in respect of closure of stores (lease     |      |     
| |    | termination costs and other)                     |      |      |     
| |    | Compensation of termination of private label     |      |     
| |    | franchise                                        |      |      |     
| |    | Other, net                                       |      |      |     
| |    |                                                  |      |      |     
| |    |                                                  |      |     
| |    |                                                  |      |      |     
| |    |                                                  |      |      |     

| | (1) | Mainly
impairment losses in respect of fixed assets, see Note 4b.
| | --- | -----------------------------------------------------------------

| | (2) | As
a result of adoption of an efficiency plan by the Company that includes
          termination of employees and closure of a number of unprofitable stores, the
          Companys consolidated statement of operations for the year ended December
          31, 2003 includes expenses in an amount of approximately NIS 26 million in
          respect of termination benefits and approximately NIS 23.5 million in respect
of           impairment of fixed assets relating to closure of unprofitable stores
          (impairment loss included in the above caption  impairment of fixed
          assets). In 2004 the Company has recorded additional amount of
          approximately NIS 4.7 million in respect of the abovementioned efficiency plan.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 47

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | (3) | Following
the change in the control of the Company, agreements were reached           between the
Company and its employees and management pursuant to which the           employees are
entitled to receive certain bonuses and additional future           benefits, which
include a bonus equivalent to 1% of the amount of every dividend           to be
distributed by the Company to its shareholders, up to a maximum cumulative
          dividend distribution of U.S.$250 million. It was also agreed that in the event
          the Company makes another public offering of its shares, the Company will offer
          to the employees to purchase up to 10% of the shares offered to the public at a
          price not exceeding 80% of 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.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of the abovementioned agreements, the Company recorded an expense of
approximately NIS 63.9 million (before income taxes and minority interest) in respect of
the aforementioned compensation and benefits to which the employees are entitled.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES:
|------- | - | ----------------------------------

| | a. | The
Company and its subsidiaries perform business operations involving the           purchase
of merchandise, fuel, the operation of food stores in the           Companys
branches, the arrangement of various promotions, etc., with           related parties, in
the course of normal business and under normal trade terms.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
group of main related parties of the Company comprises, among others: Bronfman Alon Ltd.,
Alon Israel Oil Company Ltd., Palace candles Inc., Bronfman Fisher Investments Ltd.,
IKEA, 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, among others, the Companys directors.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
view of the large number of the Companys related parties and in view of the scope
of the Companys operations, the Company and its subsidiaries are likely to perform
 in the course of normal business and under normal trade terms  an extremely
large number of transactions with the Companys related parties (hereafter: transactions
that are not exceptional).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Undoubtedly,
the mere identification of the aforesaid transactions that are not exceptional, and their
description in the Companys financial statements, gives rise to special
difficulties.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 48

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES(continued):
|------- | - | ---------------------------------------------

| | b. | Previous
parent cooperative:
| | -- | ----------------------------

| |                    | 2003 | 2004 | 2005
| | ------------------ | ---- | ---- | ----
|
|
|
|
| | Financial expenses |      |      |     
| |                    |      |      |     
| |                    |      |     
| | Rent expense       |      |      |     
| |                    |      |      |     
| |                    |      |     
| | Management fees *) |      |      |     
| |                    |      |      |     

| | *) | Management
fees related to the period until June 2003 were charged according to agreement with the
previous parent cooperative.
| | -- | -------------------------------------------------------------------------------------------------------------------------------

| | Transactions
with a previous parent cooperative involving investment and fixed assets were recorded at
the carrying amount of such assets; the results of differences were credited to
additional paid in capital.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Bronfman
 Alon Ltd. (the parent company) and other related parties:
| | -- | --------------------------------------------------------------------

| |                               | 2003 | 2004 | 2005
| | ----------------------------- | ---- | ---- | ----
|
|
|
|
| | Purchase of merchandise (3)   |      |      |     
| | Management fees               |      |      |     
| | Directors' fees (1)           |      |      |     
| | Legal consulting              |      |      |     
| | Consulting (2)                |      |      |     
| | Purchase of fuel products (3) |      |      |     
| | Commissions (4)               |      |      |     
| | Sale of gift certificates (5) |      |      |     
| | Employees discounts (6)       |      |      |     

| | 1) | Represents
payments in respect of directors fees for two directors of the           Company
and its subsidiary, in accordance with an agreement providing that each           of the
directors are entitled to monthly remuneration in the amount of NIS 42
          thousand.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Represent
payments to S. Zohar in respect of consulting agreement signed on           June 2003
untill November, 2005 when he ceased supplying consulting services. In           March
2004, S. Zohar became a director of the Company and so the amount recorded
          above represents the fee payment as explained. On September 15, 2005, S. Zohar
          resigned from his position as a director in the Company
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | The
Company and its subsidiary purchase from related parties fuel products and
          merchandise at market prices.
| | -- | ----------------------------------------------------------------------------------------------------------------------

F - 49

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES(continued):
|------- | - | ---------------------------------------------

| | 4) | In
January 2004 the shareholders of the Company approved an agreement according           to
which the Company will provide to a related party purchasing and supply
          services for stores operated by the related party. 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) | The
Company sells Blue Square gift certificates to its customers.           The
gift certificates are sold at their par value, less a discount, in           accordance
with commercial terms agreed with each customer through negotiations           conducted
during the course of normal business. In 2005, the total proceeds           received for
purchase gift certificates, which are sold mainly to interested           parties and
related parties of the Company, amounted to NIS 2.3 million.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6) | 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)
(hereafter                 the entitled employees).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
discounts to be given to the entitled employees will be identical to those given to the
Companys employees, which as of the date of approval of the financial statements,
are: 14% at the Super Center stores, 9% at the Mega stores and 4% at the Shefa Shuk
stores.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
discounts are limited to purchases in a total amount of NIS 7,000 a month.
| | ------------------------------------------------------------------------------

| | The
Companys employees enjoy and/or will enjoy employee discounts and/or various
discounts and/or special offers, which are provided by the various groups.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to agreement signed with Dor Alon in connection with the purchase of Diners Israel and
establishing a joint customer club, see note 9b(1).
| | ---------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 17 |  | SUBSEQUENT
EVENTS
|------- | - | -----------------

| | On
March 21, 2006 the Board of Directors declared a dividend in the amount of NIS 50 million
(see note 10b)
| | -----------------------------------------------------------------------------------------------------------

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE U.S.A :
|------- | - | ------------------------------------------------------------------------------------------------------------

| | a. | The
consolidated financial statements of the Company are prepared in accordance
               with accounting principles generally accepted in Israel (Israel GAAP),
which                vary in certain respects from accounting principles generally
accepted in the                United States of America (U.S. GAAP), and as allowed by
item 17 to Form 20-F, as                described below:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 50

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 1. | Effect
of inflation
| | -- | -------------------

| | In
accordance with Israeli GAAP, until December 31, 2003, when the adjustment of financial
statements for the effects of inflation in Israel was discontinued, the group
comprehensively included the effect of the changes in the general purchasing power of
Israeli currency in its financial statements, as described in note 2a above. In view of
the inflation in Israel, this was considered a more meaningful presentation than
financial reporting based on nominal cost.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
explained in note 2a above, the amounts adjusted for the effects of inflation in Israel,
presented in the financial statements as of December 31, 2003 (hereafter  the
transition date), were used as the opening balances for the nominal financial
reporting in the following periods. As a result, amounts reported in 2004 and 2005 for
non-monetary and capital items that originated before the transition date are based on
their adjusted December 2003 shekel balance.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
allowed by the SEC, the adjustments to reflect the changes in the general purchasing
power of Israeli currency, have not been reversed in the reconciliation of Israeli GAAP
to U.S. GAAP.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Proportionate
consolidation
| | -- | ---------------------------

| | Under
Israeli GAAP, jointly controlled entities are included in the Companys consolidated
financial statements according to the proportionate consolidation method.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, investments in jointly controlled entities are accounted for by the equity
method. Pursuant to the Securities and Exchange Commission requirements applicable to
foreign private issuers, the Company is not required to disclose the differences in
classification that result from using proportionate consolidation. For the Companys
share in assets, liabilities, revenues, expenses and cash flows data of jointly
controlled companies consolidated by the proportionate consolidation method, see note 3c.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Deferred
income taxes
| | -- | ---------------------

| | Under
Israeli GAAP through December 31, 2004, deferred income taxes are not provided for
differences between the accounting basis and income tax basis of land and of fixed assets
with depreciable lives in excess of 20 years that arise from adjustments for changes in
the Israeli CPI. Commencing January 1, 2005, under the new Israeli standard (see note
2l), deferred taxes are provided for land and for land component in newly acquired
businesses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, deferred taxes are provided on all such differences between the accounting
basis and income tax basis of land and fixed assets.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

F - 51

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 4. | Liability
for employee rights, net of amount funded
| | -- | ---------------------------------------------------

| | According
to U.S. GAAP, accrued severance pay and related funded amounts are presented in the
balance sheet separately as a liability and asset, respectively. Income from earnings on
amounts funded is added to severance pay funds.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to Israeli GAAP, accrued severance pay liability is included in the balance sheet net of
any related funded amounts including the income from earnings on amounts funded.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | See
Note 8c for the presentation in the Companys balance sheet.
| | ----------------------------------------------------------------

| | 5. | Earnings
(loss) per share
| | -- | -------------------------

| | According
to Israeli GAAP, the dilutive effect of convertible securities is included in the
computation of basic earnings (loss) per share if their exercise or conversion is
considered to be probable, even if their effect is antidilutive. Calculation of the
probability is based on the ratio between the market price of the shares and the present
value of the payments for conversion of the debentures into shares. According to US GAAP,
basic earnings (loss) per share exclude all dilutive securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
above difference did not have an effect on the computation of basis earnings (loss) per
share for the reported period.
| | --------------------------------------------------------------------------------------------------------------------------

| | In
addition, under US GAAP, shares resulting from conversion of convertible securities
during a reporting period are included in the computation of basic earnings (loss) per
share on a weighted average basis  based on the period from the date of conversion,
whereas under Israeli GAAP such shares are included in the computation of basic earnings
(loss) per share from the beginning of the reporting period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Another
difference is the U.S. requirement for separate presentation in the statements of
operations of basic and diluted EPS, while, in Israel, such separate presentation is only
required if the difference between basic and diluted EPS is in excess of 5%.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | Derivative
instruments
| | -- | ----------------------

| | Under
Israeli GAAP, as noted in note 2v, the Company accounts for its derivative instruments as
hedging instruments. Under U.S. GAAP, in accordance with the provisions of FAS 133 (as
amended by FAS 137, FAS 138 and FAS 149), the Companys derivative instruments do
not qualify for hedge accounting.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, under Israeli GAAP, gains and losses on derivatives that are hedging declared
dividend are deducted or added to the dividend amount whereas under U.S GAAP changes in
the fair value of those derivatives are carried to the statements of operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 52

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 7. | Goodwill
| | -- | --------

| | Under
Israeli GAAP, goodwill is amortized in equal annual installments over a period of 10 and
20 years (see note 2b(3)), Goodwill is reviewed for impairment when circumstances
indicate the possibility that impairment exists.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Commencing
January 1, 2006, under an amendment to Israeli Standard No. 20, goodwill will no longer
be amortized and will be tested for impairment at least annually (see note 2w(5)).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, goodwill is no longer amortized but tested for impairment at least annually or
between annual tests in certain circumstances, and written down when impaired. Goodwill
attributable to reporting units is tested for impairment by comparing the fair value of
the related reporting unit with its carrying value. Fair value is determined by the
Company based on market value of the reporting unit. The reporting unit to which most of
the goodwill was attributed is a subsidiary, whose shares are traded on the Tel-Aviv
stock exchange, and therefore its fair value is determined by the Company based on its
shares market value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | Impairment
of long-lived assets
| | -- | -------------------------------

| | Under
Israeli GAAP, when indicators of impairment are present, the company evaluates whether
the carrying amount of an asset exceeds its recoverable amount and recognizes an
impairment loss for the amount by which the carrying amount of the asset exceeds its
recoverable amount. Recoverable amount is defined as the higher of an assets
selling price and its value in use. Value in use is the present value of estimated future
cash flows expected to arise from the continuing use of an asset and from its disposal
and retirement at the end of its useful life.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP (SFAS 144  Accounting for the Impairment or Disposal of
Long-Lived Assets) an impairment loss is recognized only if the carrying amount of
an asset is not recoverable. The carrying amount is not recoverable if it exceeds the
estimated undiscounted future cash flows expected to result from the use of the asset. If
the carrying amount is not recoverable, an impairment loss should be recorded for the
amount by which the carrying value of the asset exceeds its fair value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result, certain circumstances which would require an impairment loss to be recorded
under Israeli GAAP would not require an impairment loss to be recorded under U.S. GAAP.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, in accordance with Israeli GAAP, where indicators are present that beneficial
events have occurred or beneficial changes in circumstances have taken place, the
impairment provision in respect of the asset (other than goodwill) may be cancelled or
reduced in the future, while under U.S.GAAP, this impairment loss cannot be restored and
the asset is continued to be carried at its new cost.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 53

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 9. | Compensation
expense in respect of options issued to employees
| | -- | --------------------------------------------------------------

| | Under
Israeli GAAP, the 1996 Stock Option Plan and previous options plans (which do not exist
any more) do not require the recognition of compensation expense.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the purpose of the reconciliation to U.S. GAAP, the Company has adopted the provisions of
APB Opinion No. 25 Accounting for Stock Issued to Employees. Under APB 25,
the excess, if any, of the quoted market price of the shares at the grant date over the
exercise price of the stock options, is amortized to compensation expense over the
vesting period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
respect of the reconciliation to U.S. GAAP for the reported periods, the effect of the
aforementioned difference is a reduction in retained earnings with an offsetting increase
in additional paid-in capital and with no effect on the Companys results of
operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10. | Dividend
declared subsequent to balance sheet date
| | --- | --------------------------------------------------

| | In
accordance with Israeli GAAP, dividends declared subsequent to balance sheet date are
presented as a separate component in shareholders equity. Under U.S. GAAP, such
dividends are not recorded as a separate component in shareholders equity.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 11. | Start-up
costs
| | --- | --------------

| | According
to Israeli GAAP, start up costs of a discontinued affiliate sold to the previous parent
cooperative, were capitalized and amortized over a period of between 3 and 5 years.
According to U.S. GAAP, such start up costs are charged to expense as incurred.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 12. | Classification
of certain expenses
| | --- | ----------------------------------

| | Under
Israeli GAAP, certain expenses (income) amounting to approximately NIS (0.7) million, NIS
20 million and NIS 137 million for the years ended December 31, 2005, 2004 and 2003
respectively, are included in non-operating expenses (see note 15j), whereas in
accordance with U.S. GAAP such items are included in operating expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 13. | Cash
flow classification
| | --- | ------------------------

| | According
to Israeli GAAP, proceeds from sale or purchase of marketable securities are presented in
cash flows from investing activities in the statement of cash flows.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP, proceeds from sale or purchase of marketable securities which are
classified by the Company as trading securities are included in cash flows from operating
activities.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 54

---

---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 14. | Convertible
debentures
| | --- | ----------------------

| | Under
U.S. GAAP, in accordance with EITF No. 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and
EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments,
embedded beneficial conversion features included in convertible securities should be
valued separately at issuance. The embedded beneficial conversion feature should be
recognized and measured by allocating a portion of the proceeds equal to the intrinsic
value of that feature to additional paid-in capital. That amount should be calculated at
the commitment date as the difference between the conversion price and the fair value of
the common stock or other securities into which the security is convertible, multiplied
by the number of shares into which the security is convertible.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
described in Note 7a(2), the conversion price of the convertible debentures is subject to
adjustment, among others, upon the distribution of a cash dividend, which accordingly
results in a contingent beneficial conversion feature that should be recognized under
EITF No. 98-5 and EITF No. 00-27. Under issue 7 of EITF No. 00-27, the Company should
recognize the beneficial conversion feature only when the conversion price is adjusted
below the share market price on the commitment date (market price on the date of the
issuance of the convertible debentures).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
described in Note 7a(2), due to dividend distributions in 2005 and 2004, the conversion
price was adjusted to NIS 32.89 and NIS 35.2, as of December 31, 2005 and 2004,
respectively. These prices are below the market price of the shares at the commitment
date (NIS 42.4). Accordingly, under U.S. GAAP, the Company recorded in 2005 and 2004 a
beneficial conversion feature (credited to additional paid-in capital (APIC)
amounting to NIS 15,650 thousand (NIS 11,444 thousand after taking into consideration
deferred taxes) and NIS 37,721 (NIS 24,658 thousands, after taking into consideration
deferred taxes) thousand, respectively, which equals the difference between the market
price of the shares at the commitment date and the adjusted conversion price, multiplied
by the number of shares resulting from the conversion.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
resulting discount on the convertible debentures is accreted over the remaining term of
the debentures. Accordingly, the Company recorded, under U.S. GAAP, for the years ended
December 31, 2005 and 2004, additional interest expense in the amount of NIS 11,690
thousand (NIS 7,715 thousand after taxes) and NIS 9,014 thousand (NIS 5,859 thousand
after taxes), respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to balance sheet date, the conversion price was further adjusted to NIS 31.6, due to of
another dividend distribution, see note 17. As a result, the Company will record in 2006
an additional discount on the debentures, in an amount of approximately NIS 9,462
thousand (NIS 7,224 thousand after taxes) against a credit to APIC.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
Israeli GAAP, the beneficial conversion feature component is not recognized in the
financial statements.
| | --------------------------------------------------------------------------------------------------------------

F - 55

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BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | However,
under the transition provisions of Israeli standard No.22, effective January 1, 2006, the
company will have to bifurcate the equity component from these convertible debentures,
see note 2w(1).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 15. | Reporting
comprehensive income
| | --- | ------------------------------

| | U.S.
GAAP require reporting and display of comprehensive income and its components
          in a full set of general purpose financial statements. Israeli GAAP does not
          contain such a requirement. With respect to the Company, comprehensive income
          does not include any items other than net income.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
effects on the financial statements of the abovementioned material           differences
between Israeli GAAP and U.S. GAAP are as follows:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Consolidated
statements of operations:
| | -- | --------------------------------------

| |                                                            | 2003 | 2004 | 2005
| | ---------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Net income (loss) as reported, according   to Israeli GAAP |      |      |     
| | Amortization of goodwill ,see a(7)                         |      |      |     
| | Accretion of discount resulting from                       |      |     
| | beneficial conversion feature in                           |      |     
| | respect of convertible debentures ,see                     |      |     
| | a (14)                                                     |      |      |     
| | Gains on derivatives ,see a (6)                            |      |      |     
| | Impairment of long-lived assets ,see a(8)                  |      |      | *)  
| | Taxes in respect of the above                              |      |      |     
| | Deferred taxes on income ,see a(3)                         |      |      |     
| | Minority interest in respect of the above                  |      |      |     
| |                                                            |      |      |     
| | Net income (loss) according to U.S. GAAP                   |      |      |     
| |                                                            |      |      |     
| | Net income (loss) per share as reported,                   |      |     
| | according to Israeli GAAP (basic and                       |      |     
| | fully diluted):                                            |      |      |     
| |                                                            |      |      |     
| |                                                            |      |     
| | Net income (loss) per share Per U.S. GAAP:                 |      |     
| | Basic and diluted earnings (loss) per                      |      |     
| | share, see a(5)                                            |      |      |     
| |                                                            |      |      |     
| |                                                            |      |     
| | Weighted average number of shares used                     |      |     
| | for computation of earning (loss) per                      |      |     
| | share (basic and diluted)                                  |      |      |     
| |                                                            |      |      |     

| | *) | Includes:
| | -- | ---------

| | 1. | Difference
in depreciation expense due to different cost basis of fixed assets
               between Israeli GAAP and U.S. GAAP resulting from different impairment
charges.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 56

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BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 2. | Difference
due to reversal of impairment losses previously recognized under           Israeli GAAP,
which is not permitted under U.S. GAAP.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Difference
due to impairment losses recognized under U.S. GAAP in the current           period,
whereas under Israeli GAAP such impairment losses were included in           previous
periods.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Consolidated
balance sheets:
| | -- | ----------------------------

|                           | December 31, 2004 | December 31, 2005
|-------------------------- | ----------------- | -----------------
|
|
|
|
|Severance pay fund (6)     |                   |                  
|Cost of fixed assets       |                   |                  
|Accumulated depreciation   |                   |                  
|and amortization           |                   |                  
|(including impairment      |                   |                  
|of fixed assets) (5)       |                   |                  
|Intangible assets and      |                   |                  
|deferred charges (4)       |                   |                  
|Deferred income taxes,     |                   |                  
|net (1)                    |                   |                  
|Other accounts payable     |                   |                  
|and accrued expenses (8)   |                   |                  
|Accrued severance pay (6)  |                   |                  
|Convertible debentures (7) |                   |                  
|Minority interest (3)      |                   |                  
|Additional paid-in         |                   |                  
|capital (2)                |                   |                  
|Retained earnings :        |                   |                  
|Dividend declared          |                   |                  
|after balance sheet date   |                   |                  
|Unappropriated (3)         |                   |                  
|Total shareholders' equity |                   |                  

*) Reclassified
**)
          Excluding deferred taxes

| | (1) | Effect
of difference described in a(3) above and tax effect of difference           described in
a(8) and a(14) above.
 Accumulated depreciation and amortization           (including
impairment of fixed assets).
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Options
issued to employees (see a(9) above), difference in capital gain, net           of tax,
from transactions with the previous parent cooperative (see a(11)           above), and
difference in respect of convertible debentures (see a(14)(2)           above).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Net
effect of reconciling items.
| | --- | --------------------------------

| | (4) | As
for amortization of goodwill, see a(7) above.
| | --- | ------------------------------------------------

| | (5) | As
for the effect of Standard No. 15, see a(8) above.
| | --- | -----------------------------------------------------

| | (6) | See
a(4) above.
| | --- | ---------------

| | (7) | See
a(14)(2) above.
| | --- | -------------------

| | (8) | See
a(6) above.
| | --- | ---------------

F - 57

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BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 3. | Consolidated
statements of cash flows:
| | -- | --------------------------------------

| |                                       | Year ended December 31,
| | ------------------------------------- | -----------------------
|
|
|
|
| | Cash flows from operating activities: |                        
| |                                       |                        
| | As per Israeli GAAP                   |                        
| | Adjustment (1)                        |                        
| |                                       |                        
| |                                       |                        
| | As per U.S. GAAP                      |                        
| |                                       |                        
| |                                       |                        
| | Cash flows from investing activities: |                        
| |                                       |                        
| | As per Israeli GAAP                   |                        
| | Adjustment (1)                        |                        
| |                                       |                        
| |                                       |                        
| | As per U.S. GAAP                      |                        
| |                                       |                        

| | (1) | See
a(13) above.
| | --- | ----------------

| | c. | Recently
issued accounting pronouncements in the United States:
| | -- | ---------------------------------------------------------------

| | 1. | In
December 2004, the Financial Accounting Standards Board (FASB)
          issued the revised Statement of Financial Accounting Standards (FAS)
          No. 123, Share-Based Payment (FAS 123R), which addresses the accounting
for           share-based payment transactions in which the company obtains employee
services           in exchange for (a) equity instruments of the company or (b)
liabilities that           are based on the fair value of the companys equity
instruments or that may           be settled by the issuance of such equity instruments
..In March 2005, the SEC           issued Staff Accounting Bulletin No. 107 (SAB 107)
regarding the SECs           interpretation of FAS 123R. FAS 123R eliminates the
ability to account for           employee share-based payment transactions using APB
Opinion No. 25           Accounting for Stock Issued to Employees, and
requires instead that           such transactions be accounted for using the grant-date
fair value based method.           This Statement will be effective as of the beginning
of the annual reporting           period that begins after June 15, 2005 ( January
1, 2006 for the Company).           Early adoption of FAS 123R is encouraged. This
Statement applies to all awards           granted or modified after the Statements
effective date. In addition,           compensation cost for the unvested portion of
previously granted awards that           remain outstanding on the Statements
effective date shall be recognized on           or after the effective date, as the
related services are rendered, based on the           awards grant-date fair value
as previously calculated for the pro-forma           disclosure under FAS 123.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 58

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---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | As
the Company has no current employee or non-employee compensation plans, implementation of
the standard will have no effect on its financial statements. Nevertheless, prospective
new grants of options or shares to employees or service providers of the Company shall
result, in the following reporting periods, in the  recording
of payroll expenses or expenses relating to the cost of the services, at their fair value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
November 2004, the FASB issued FAS No. 151, Inventory Costs  an
          Amendment of ARB 43, Chapter 4 (FAS 151). This Statement
          amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to
          clarify the accounting for abnormal amounts of idle facility expense, freight,
          handling costs, and wasted material. This Statement requires that those items
be           recognized as current-period charges. In addition, this Statement requires
that           allocation of fixed production overheads to the costs of conversion be
based on           the normal capacity of the production facilities. This Statement will
be           effective for inventory costs incurred during fiscal years beginning after
June           15, 2005 (January 1, 2006 for the Company). Earlier application of FAS 151
is           permitted. The provisions of this Statement shall be applied prospectively.
The           Company does not expect this Statement to have a material effect on the
          Companys financial statements or its results of operations.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
June 2005, the Financial Accounting Standards Board issued FAS No. 154,           Accounting
Changes and Error Corrections  a replacement of APB           Opinion No. 20 and
FASB Statement No. 3". This Statement generally requires           retrospective
application to prior periods financial statements of changes           in
accounting principle. Previously, Opinion No. 20 required that most voluntary
          changes in accounting principle were recognized by including the cumulative
          effect of changing to the new accounting principle in net income of the period
          of the change. FAS 154 applies to all voluntary changes in accounting
principle.           It also applies to changes required by an accounting pronouncement
in the           unusual instance that the pronouncement does not include specific
transition           provisions. When a pronouncement includes specific transition
provisions, those           provisions should be followed. This Statement shall be
effective for accounting           changes and corrections of errors made in fiscal years
beginning after December           15, 2005 (Year 2006 for the company). The Company does
not expect the adoption           of this statement will have a material impact on its
results of operations,           financial position of cash flow.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 59

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---



BLUE SQUARE 
ISRAEL LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

|NOTE 18 |  | EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN
ISRAEL AND IN THE U.S.A  (continued) :
|------- | - | -------------------------------------------------------------------------------------------------------------------------

| | 4. | In
February 2006, the FASB issued FAS 155, accounting for certain Hybrid           Financial
Instruments, an amendment of FASB statements No. 133 and 140. This           statement
permits fair value measurement for any hybrid financial instrument           that
contains an embedded derivative that otherwise would require bifurcation.           This
statement is effective for all financial instruments acquired or issued           after
the beginning of an entitys first fiscal year that begins after           September
15, 2006. Earlier adoption is permitted as of the beginning of an           entitys
fiscal year, provided that no interim period financial statements           have been
issued for the financial year. Management is currently evaluating the           impact of
this statement, if any, on the Companys financial statements or           its
results of operations.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
March 2006 the Financial Accounting Standards Board (the FASB)
          issued Statement of Financial Reporting No. 156 (SFAS 156). This
          Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing
          of Financial Assets and Extinguishments of Liabilities, with respect to the
          accounting for separately recognized servicing assets and servicing
liabilities,           and is effective for financial periods beginning after September
15, 2006. The           Company does not currently engage in transfers of financial
assets and           accordingly does not anticipate that the adoption of this statement
will have a           material impact on its financial statements.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 60

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APPENDIX I

BLUE SQUARE 
ISRAEL LTD. 
DETAILS OF PRINCIPAL SUBSIDIARIES, PROPORTIONATELY CONSOLIDATED COMPANIES AND 
AN ASSOCIATED COMPANYAT DECEMBER
31, 2005

|Holding Company               | Name of Company | Percentage of
ownership and
control by holding
company as of
December 31,
2005 |                                   
|----------------------------- | --------------- | ------------------------------------------------------------------------------ | ----------------------------------
|
|
|
|
|Blue Square-Israel Ltd.       |                 |                                                                                | The Blue Square Chain             
|                              |                 |                                                                                | Investments & Properties Ltd.     
|                              |                 |                                                                               
|                              |                 |                                                                                | Hamachsan Hamerkazi Kfar          
|                              |                 |                                                                                | Hasha'ashuim Ltd                  
|                              |                 |                                                                               
|                              |                 |                                                                                | Kenyon Hadar Management           
|                              |                 |                                                                                | Company Ltd.                      
|                              |                 |                                                                               
|                              |                 |                                                                                |                                   
|                              |                 |                                                                                | Joint venture Blue Square - Hadar 
|The Blue Square Chain         |                 |                                                                                | The Blue Square Chain (Hyper      
|Investments & Properties Ltd. |                 |                                                                                | Hyper) Ltd.                       
|                              |                 |                                                                               
|                              |                 |                                                                                |                                   
|                              |                 |                                                                                | Center Investments 1108 Ltd.      
|                              |                 |                                                                               
|                              |                 |                                                                                |                                   
|                              |                 |                                                                                | Izdarehet Investments Company Ltd.
|The Blue Square Chain (Hyper  |                 |                                                                               
|Hyper)  Ltd.                  |                 |                                                                                | Hyper Lod Center Ltd.             
|                              |                 |                                                                               
|                              |                 |                                                                                | Kenyon Malha Jerusalem Partnership
|                              |                 |                                                                               
|                              |                 |                                                                                | Shefa Mehadrin Ltd.               
|                              |                 |                                                                               
|                              |                 |                                                                                | Radio Non-Stop Ltd.               

F - 61

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APPENDIX II

REPORT OF INDEPENDANT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of

HAMACHSAN HAMERKAZI
KFAR HASHAASHUIM LTD.

We
have audited the accompanying consolidated balance sheets of Hamachsan Hamerkazi Kfar
Hashaashuim Ltd. (the Company) and its subsidiaries as of December 31, 2005,
and the related consolidated statements of operations, changes in shareholders
equity and cash flows for of the year ended December 31, 2005 (not presented separately
herein). These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements
based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the companys
internal control over financial reporting. An audit includes consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In
our opinion, based on our audits, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2005, and the consolidated results of
their operations and cash flows for the year ended of December 31, 2005, in conformity
with Israel generally accepted accounting principles, which differ in certain respects
from those followed in the United States, as described in Note 22 to the consolidated
financial statements.

|                                 |                                                                    
|-------------------------------- | -------------------------------------------------------------------
|
|
|
|
|Tel-Aviv, Israel 
March  5, 2006 | /S/ KOST, FORER GABBAY & KASIERER
 A Member of Ernst & Young Global

F - 62

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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/ Gil Unger
Gil UngerPresident and Chief Executive
Officer
| |  | -----------------------------------------------------------------------------------------------------

| |  | By: /s/ Emanuel Avner
Emanuel AvnerVice President and Chief  Financial
Officer
| |  | --------------------------------------------------------------------------------------------

Date: June 28, 2006



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