---

---

# 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, 2006
|- | --------------------------------------------------------------------------------------------------------------------------------

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, eachrepresenting one Ordinary Share (1) | New York Stock Exchange, Inc.            

|                                                 |                              
|------------------------------------------------ | -----------------------------
|Ordinary
Shares, par value NIS 1.0 per share (2) | New York Stock Exchange, Inc.

|(1) | Evidenced
by American Depositary Receipts.
|--- | ------------------------------------------

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

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



---

---



|                
|----------------
|None            
|                
|(Title of Class)

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

|                
|----------------
|None            
|                
|(Title of Class)

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

39,692,983 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  x | Non-accelerated filer  o

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 (c) BSIP means Blue Square Chain Investments & Properties
Ltd., a corporation of which we held 80% of the outstanding shares as of May 31, 2007, and
the balance of whose shares are publicly held and traded on the Tel Aviv Stock Exchange
and (d) BSRE means Blue Square Real Estate Ltd., a corporation of which we
held 80% of the outstanding shares as of May 31, 2007, and the balance of whose shares are
publicly held and traded on the Tel Aviv Stock Exchange. As of December 31, 2005, the
Company transferred all of its directly-owned real estate assets and certain liabilities
to BSRE.

We
are the second largest 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 2006, 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 toy and housewares sections within most of
our large stores. As of December 31, 2006, we owned and operated 175 supermarkets
under the brand names Mega, Super Center and Shefa Shuk. For further information regarding
our real estate, see Item 4. Information on The Company  B. Business Overview
 Real Estate.

Unless
otherwise indicated, as used in this Annual Report, the term owned or
ownership with respect to our supermarkets means the ownership of the
operations of our supermarkets, and not legal title to the real estate underlying our
supermarkets.

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

Except
for the historical information contained herein, the statements contained in this Annual
Report are forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995, with respect to our business, financial condition and
operating results. Actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including all the risks
discussed in Item 3. Key Information  D. Risk Factors and elsewhere in
this Annual Report.



---

---



We
urge you to consider that statements which use the terms believe, do not
believe, expect, plan, intend,
estimate, anticipate, project and similar expressions
are intended to identify forward-looking statements. These statements reflect our current
views with respect to future events and are based on assumptions and are subject to risks
and uncertainties. Except as required by applicable law, including the securities laws of
the United States, we do not undertake any obligation nor intend to update or revise any
forward-looking statements, whether as a result of new information, future events or
otherwise.

All
references in this Annual Report to dollars or $ are to U.S. dollars and all references in
this Annual Report to NIS are to New Israeli Shekels. Unless mentioned otherwise, all
figures in U.S. dollars are based on the representative exchange rate between the NIS and
the dollar as published by the Bank of Israel for December 31, 2006, which was NIS
4.225 per $1.00, except figures for the first quarter of 2007, which are based on the
representative exchange rate between the NIS and the dollar as published by the Bank of
Israel for March 31, 2007, which was NIS 4.155 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. In accordance with Israeli Accounting Standard No. 29 of
the Israel Accounting Standard Boards, we will begin reporting under International
Financial Reporting Standards (IFRS) commencing with financial periods beginning January
1, 2008. See Item 3. Key Information  D. Risk Factors.

# NOTE REGARDING
TRANSITION TO NOMINAL-HISTORICAL FINANCIAL REPORTING

With
effect from January 1, 2004, the Company has adopted the provisions of Israeli Accounting
Standard No. 12, Discontinuance of Adjusting Financial Statements for Inflation,
of the Israel Accounting Standard Boards 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 companies and equity items, which originate from the period that preceded the
transition date, are based on the adjusted-for-inflation data (based on the consumer
price index (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 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 non-monetary
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                                                   | 16  
|ITEM4A.   | UNRESOLVED STAFF COMMENTS                                                    | 44  
|ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 | 44  
|ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   | 71  
|ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            | 92  
|ITEM 8.   | FINANCIAL INFORMATION                                                        | 101 
|ITEM 9.   | THE OFFER AND LISTING                                                        | 104 
|ITEM 10.  | ADDITIONAL INFORMATION                                                       | 106 
|ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 122 
|ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 125 
|PART II   |                                                                              | 125 
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 125 
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 125 
|ITEM 15.  | CONTROLS AND PROCEDURES                                                      | 125 
|ITEM 16.  | [RESERVED]                                                                   | 126 
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                             | 126 
|ITEM 16B. | CODE OF ETHICS                                                               | 127 
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                       | 127 
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                   | 128 
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       | 128 
|PART III  |                                                                              | 129 
|ITEM 17.  | FINANCIAL STATEMENTS                                                         | 129 
|ITEM 18.  | FINANCIAL STATEMENTS                                                         | 129 
|ITEM 19.  | EXHIBITS                                                                     | 129 

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,
2005 and 2006 and for each of the years ended December 31, 2004, 2005 and 2006 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, 2002,
2003, and 2004 and for each of the years ended December 31, 2002 and 2003 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

---

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|                                                  | 2002 | 2003 | 2004 | 2005      | 2006 | 2006
|------------------------------------------------- | ---- | ---- | ---- | --------- | ---- | ----
|
|
|
|
|Income Data                                       |      |      |      |           |      |     
|Sales                                             |      |      |      | 5,444,306 |      |     
|Cost of sales                                     |      |      |      | 3,974,628 |      |     
|Gross profit                                      |      |      |      | 1,469,678 |      |     
|Selling, general and administrative expenses      |      |      |      | 1,250,662 |      |     
|Operating income                                  |      |      |      | 219,016   |      |     
|Financial income (expenses), net                  |      |      |      | 15,900    |      |     
|Amortization of goodwill                          |      |      |      | (5,277    | )    |     
|Other income (expenses), net                      |      |      |      | (174,004  | )    |     
|Taxes on income                                   |      |      |      | 42,078    |      |     
|Equity in net earnings (loss) of affiliates       |      |      |      | (363      | )    |     
|Minority interest                                 |      |      |      | 5,953     |      |     
|Net income (loss)                                 |      |      |      | 7,241     |      |     
|Earnings (loss) per ordinary share or ADS (basic) |      |      |      | 0.19      |      |     
|Earnings (loss) per ordinary share or ADS         |      |     
|(fully diluted)                                   |      |      |      | *0.19     |      |     
|Cash dividends declared per ordinary share or ADS |      |      |      | 3.33      |      |     
|U.S. GAAP:                                        |      |     
|Net income (loss)                                 |      |      |      | 62,596    |      |     
|Earnings (loss) per ordinary share or ADS (basic) |      |      |      | 1.63      |      |     
|Earnings (loss) per ordinary share or ADS         |      |     
|(fully diluted)                                   |      |      |      | 1.63      |      |     
|Selected Operating Data:                          |      |     
|Number of stores (at year end)                    |      |      |      | 173       |      |     
|Increase (decrease) in same store sales(3)        |      |      |      | (12.0     | )%   |     
|Total square meters (at year end)                 |      |      |      | 292,600   |      |     
|Sales per square meter (in NIS)(4)                |      |      |      | 19,229    |      |     
|Sales per employee (in thousands)(5)              |      |      |      | 799       |      |     

---

| | (1) | For
the years 2002-2003, 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, 2006 (NIS 4.225 =$1.00), as published by the Bank of
Israel.                During 2006, the US dollar depreciated in value vis-à-vis
the NIS by                8.2%.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | The
Companys Same Store Sales calculation is based on stores: (1) that
               have operated continuously throughout the current and prior reporting
period                (e.g., stores that were open on January 1, 2005 and were not
permanently                closed during 2005 or 2006); and (2) that have not been
resized significantly                during the period.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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 and 2006 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.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

2

---

---



| | * | After
retroactive application of accounting change. Commencing January 1, 2006, the
Company applies the provisions of Israeli Accounting Standard No. 21 of the IASB,
Earnings per Share. The computation of basic net income per share is
generally based on earnings available for distribution to holders of ordinary shares
divided by the weighted average number of ordinary shares outstanding during the period.
In computing diluted net income per share, the weighted average number of shares to be
issued, assuming that all dilutive potential shares are converted into shares, is to be
added to the average number of ordinary shares used in the computation of the basic
income per share. Potential shares are taken into account, as above, only when their
effect is dilutive (reducing net income or increasing loss per share from continuing
activities). Comparative net income per share figures included in this Annual Report
reflect a retrospective application of the new standards computation directives.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | 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 2002-2003, 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, 2006 (NIS 4.225 = $1.00), as published by the
Bank of                Israel.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | Reclassified.
|- | -------------

| | 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.

3

---

---



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

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 chains and 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.

We
believe that an important factor in the purchase decisions of a large portion of the
Israeli public is the price of the products it purchases. As a result, in recent years, we
and our competitors have established or expanded low-price and hard discount stores
formats.

In
addition, private supermarkets during 2006 increased their market share and expanded their
presence in selected areas in Israel, often geographically beyond their original
locations, increasing competition in an already difficult market. Based on A.C. Nielsen,
we estimate that the private supermarkets market share was approximately 24.5% of
the bar-coded market in Israel in 2006. The low barriers of entry, including the
relatively low cost of establishing a new private supermarket, have contributed to the
increase in number and expansion of private supermarkets in recent years. 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.

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. In 2006, the Fourth Chain Company
started to market a private label brand. This combination, and possible similar
combinations of other private supermarkets, 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. Based on A.C. Nielsen, we estimate that Super Sols market share was
approximately 37.7% of the bar-coded market in Israel in 2006, as opposed to our own
approximately 25% share of the bar-coded market in 2006. 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 2006, Tnuvas products accounted for approximately 13%
of all the products sold at our supermarkets. In addition, the Strauss group, an Israeli
food manufacturer, accounted in 2006 for approximately 9.5% of all products sold at our
supermarkets, and the Osem group accounted for approximately 6.6% of all products sold at
our supermarkets in 2006. Because of our status as a leading food retailer in Israel as a
result of which we are able to offer a wide exposure and promotion, on a national level,
to these suppliers products, and the fact that we maintain an excellent and
long-standing relationship with Tnuva, Strauss group and Osem, we do not believe that
there is a material risk of future stoppage of supply of products of these key suppliers.
However, we do not have a written contract with Tnuva, Strauss group or Osem obligating
them to supply products to us. The ten largest suppliers accounted for approximately 51.2%
of our products purchases in 2006. 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 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

---

---



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

As
of June 21, 2007, Alon Retail Ltd., formerly Bronfman-Alon Ltd. (Alon Retail),
owned approximately 70.6% of Blue Squares ordinary shares following the conversion
by other investors of an aggregate of approximately NIS 122.5 million in principal amount
of our 5.9% convertible debentures since their issuance in August 2003. So long as Alon
Retail, or any successor to its shareholdings in Blue Square, continues to own
beneficially more than 50% of our outstanding ordinary shares and voting power, it will be
able to control the outcome of matters requiring shareholder approval, 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.

Blue
Squares two main subsidiaries are BSIP and BSRE, in each of which Blue Square owned
an 80% interest as of December 31, 2006.

Of
the 175 supermarkets that we operated as of December 31, 2006, we owned directly 110, and
the remaining 65 supermarkets were owned by BSIPs subsidiaries, each of which has
its own board of directors. These subsidiaries include 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% 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
supermarket sales of BSIP and its subsidiaries in 2006 aggregated approximately NIS 4,022
million, or $952 million, representing approximately 64% of our consolidated supermarket
sales for 2006.

Blue
Square leases from BSRE and BSIP the real estate underlying a majority of the supermarkets
that it owns. BSRE has its own board of directors and has no retail activities. The
ordinary shares of BSRE that are not owned by Blue Square are publicly held and traded on
the Tel Aviv Stock Exchange.

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 cancellation of such transactions, require the approval of the
audit committee, the directors, and, under certain circumstances, approval of the
shareholders of the subsidiary by special vote and are subject to the receipt of
applicable permits and approvals. In addition, any dividend or distribution from a
subsidiary requires the approval of the directors of that subsidiary, and may be subject
to restrictions imposed by loan and other agreements to which they are parties.

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. Coalition guidelines adopted in 2006 by the Israeli government
announced a goal of increasing the minimum monthly wage to NIS 4,600 (at such time,
$1,000), to be reached in two stages. In the first stages, the minimum monthly wage was
increased on June 1, 2006 to NIS 3,585, or approximately $850, and on April 1, 2007, was
increased to NIS 3,710, or approximately $893. Pursuant to existing legislation, the
minimum wage is to be increased further effective as of December 1, 2007, to NIS 3,850.
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;
|- | -------------------------------------------------------------------------------------------------------------------

7

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| | changes
in financial estimates by securities analysts;
|- | ------------------------------------------------------

| | conditions
or trends in our business;
|- | -------------------------------------

| | changes
in the market valuations of our competitors;
|- | ----------------------------------------------------

| | announcements
by us or our competitors of significant acquisitions;
|- | -------------------------------------------------------------------

| | entry
into strategic partnerships or joint ventures by us or our competitors;
|- | -----------------------------------------------------------------------------

| | the
political, economic, security and military conditions in Israel;
|- | --------------------------------------------------------------------

| | additions
or departures of key personnel; and
|- | ---------------------------------------------

| | sales
of ordinary shares by Blue Square's controlling shareholder.
|- | ------------------------------------------------------------------

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

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

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

In
connection with our issuance of NIS 400 million in aggregate principal amount of unsecured
5.9% convertible and nonconvertible debentures in August 2003, Blue Squares board of
directors resolved that Blue Square would not distribute dividends in any quarter if the
ratio of our 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 of directors 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 of directors resolution may lead
to a downgrading of the rating on our 5.9% unsecured debentures. Following the dividends
distributions of 2003 through 2006, the retain earnings of Blue Square decreased
significantly. To maintain the credit rating of our 5.9% unsecured debentures, 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 as of May 31, 2007 were convertible into Blue Square ordinary shares at per
share price of NIS 28.625. This conversion ratio is subject to adjustment in the event of
distribution of bonus shares, cash dividends and the issuances of rights. On May 31, 2007,
the closing price per share of our ordinary shares on the Tel Aviv Stock Exchange was NIS
75.27.

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 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.

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.

9

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

In
his final position, the Commissioner announced certain operational measures, including
among other, instructions to the legal department of the Israeli Antitrust Authority 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.

We
and the other major chains held meetings with the Commissioner with respect to the
contents of a proposed consent decree which the Commissioner delivered to us and to the
other major chains; however, we did not reach an understanding with the Commissioner and
our negotiations 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.

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

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

Impact of inflation might increase
our financial expenses, thereby affecting our operating results. Increases in oil, raw
material and product prices in recent years may affect our operating results.

Our
assets and shareholders equity are not adjusted to the inflation in Israel, while the
repayment of interest and principal under most of our loans and all debentures is linked
to the Israeli CPI, as provided in our loan and debenture agreements. As a result, an
increase in inflation in Israel would have the effect of increasing our financial expenses
without any corresponding offsetting increase in our assets and revenues on our financial
statements, leading to lower reported earnings and shareholders equity. The extent of this
effect on our financial statement would be dependent on the rate of inflation in Israel.

10

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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.

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

Any
devaluation of the NIS against various non-Israeli currencies in which we or our suppliers
pay for imported goods has the effect of increasing the selling price of those products
and affecting our sales and operating results.

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

Our profit margin would be
adversely affected if our ability to utilize our distribution 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 purchases during
2006. 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 and electronic prepaid cards
to institutions, companies and individuals, particularly during the High Holiday and
Passover seasons. The gift certificates and prepaid cards can be used in our stores as
well as other stores with which we entered into collaboration agreements. We are exposed
to risks connected with the issuance of gift certificates, including risks that they may
be fraudulently forged or stolen, and we are exposed to risks of computer fraud or errors
in connection with the issuance of prepaid cards. A substantial or large scale forgery,
theft, fraud or error may cause a reduction in our revenue and increases our expenses.

# 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, to the Companys knowledge, 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 Alon Retail, and
other corporations under control of the Dor Alon group and the Africa Israel group. As a
result of these regulations, some Israeli Banks are prevented from providing additional
credit to companies within our borrowing group, and we and our subsidiaries
may face limitations from time to time in our ability to obtain additional credit from
Israeli banks. This could adversely affect our ability to operate our business as we have
in the past.

11

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# 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 adoption of
international financial reporting standards could have an adverse effect on our results
of operations

In
accordance with Israeli Accounting Standard No. 29 adopted by the Israeli Accounting
Standards Boards, our financial statements will be prepared in accordance with
International Financial Reporting Standards (IFRS) beginning on or after January 1, 2008.
The IFRS are different from the Israeli GAAP standards, and therefore our financial
results under IFRS may reflect a financial condition, financial results and cash flow
which are substantially different from that which is currently reported in our financial
statements under Israeli GAAP. The implementation of IFRS requires appropriate
preparations by the Company, including making certain decisions with respect to the manner
of determining the value of assets and liabilities as of the transition date and in
connection of setting accounting policies regarding different subject matters. This may
have a material adverse effect on our financial results. As of the date of this Annual
Report, we cannot estimate the effect of the adoption of IFRS on our financial statements.
For further information regarding reporting under IFRS, see note 2x to our consolidated
financial statements.

A recent Israeli Supreme Court
decision regarding the deductibility of financial expenses for tax purposes in connection
of dividend distribution could have an adverse effect on our results of operations

In November 2006, the Israeli Supreme
Court issued a decision that finance expenses for loans incurred for the purpose of
distributing a dividend are not recognizable for tax deduction purposes (with limited
exceptions). The Supreme Court reasoned that in such a case the connection between the
expense (finance) and the income is not a direct and approximate, but rather indirect, and
therefore is not deductible for tax purposes. The company is subject to legal proceedings
in connection with the recognition of finance expenses for the years 1999-2001 in the
amount of approximately NIS 17 million. See Item 8. Financial Information  A.
Consolidated Statements and Other Financial Information  Legal Proceedings  We
are subject to legal proceedings in connection with recognition of finance expenses.
In light of the Israeli Supreme Court decision and since the company has already received
final tax assessments for 2002, dividend distributions made since 2003 or to be made in
the future may be subject to scrutiny by the Israeli Tax Authorities, which may determine
that one or more loans were deemed to be incurred for the purpose of distributing such
dividend, as a result of which the finance expenses associated with such loan may not be
deductible for tax purposes. For information regarding the Company dividend distribution,
see Item 5.  Liquidity and Capital Resources  Dividends.

12

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We are party to legal proceedings
in connection with tax assessments including potential liabilities for the years 2005 and 2006.

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 questioned under warning, with respect to
these benefits. In August 2006, the Income Tax Authority issued to the Company deduction
assessment orders for the years 2001-2002 in the amounts of approximately NIS 22 million.
In September 2006, the Company filed an appeal with the District Court contesting these
assessments. In the opinion of the Company and its advisors, the provisions included in
the Company financial statements are sufficient to cover the potential liabilities, including potential liabilities for the yesrs 2005 and 2006.

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 July 2006, a conflict with Hezbollah escalated
significantly on Israels northern border. This conflict included the firing of
multiple rockets by Hezbollah throughout northern Israel as well as retaliatory attacks by
Israel throughout Lebanon. Due to the hostilities in the northern part of Israel and
Lebanon, a number of our stores located in the northern region did not operate according
to their usual schedule. Although we were almost fully compensated by the Israeli
government for the losses and damages that we incurred as a result of this conflict in the
north, we cannot predict the effect on our business if hostilities are renewed or the
security situation deteriorates in the north or in any other part of the country, nor can
we guarantee what future compensation, if any, would be provided to us by the Israeli
government in such event.

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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.

# Economic conditions in
Israel affect our financial performance.

All
of our supermarket 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, 2005 and 2006,
it rose by 1.5%, 4.8%, 5.2% and 5.1%, respectively. The economic slowdown during 2001,
2002 and a portion of 2003 adversely affected our financial performance. Initial reports
indicate that the Israeli economy grew by 6.3% at the first quarter of 2007. 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, a few of the products we offer in our stores,
including bread, flour, eggs, milk and margarine are subject to government-imposed price
controls. In addition, during periods of high inflation in the past, more extensive price
controls have been imposed throughout Israel.

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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.

15

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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, Alon Retail (formerly Bronfman-Alon) acquired 78.1% of the outstanding shares
of Blue Square from the Co-Op following the submission by Alon Retail of 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. As of June 21, 2007, Alon Retail
owned approximately 70.6% of the outstanding shares following to the conversion by other
investors of an aggregate of approximately NIS 122.5 million in principal amount of our
5.9% convertible debentures since their issuance in August 2003.

In
September 2005, the Alon Group (controlled by Alon Israel Oil Company Ltd.),
which then owned a 50% interest in Alon Retail, acquired shares in Alon Retail held by the
Bronfman-Fisher Group (controlled by Matthew Bronfman and Yaakov Shalom
Fisher), which then also owned a 50% interest in Alon Retail. Following such acquisition,
the Alon Group owned 73.5% of Alon Retail, and the Bronfman-Fisher
Group owned 26.5%.

In
January 2007, the Alon Group completed the purchase of the remaining holdings by the
Bronfman-Fisher Group in Alon Retail for a consideration of $52.6 million. The
consideration was based on a total market value of Blue Square of approximately $588
million dollars (based on the market value of Blue Square shares minus the liabilities of
Alon Retail and minus a dividend of $11.15 million to be paid by Alon Retail to its
shareholders). The Alon Group currently beneficially owns 100% of the shares of Alon
Retail.

For
a description of the ownership in Alon Retail, please see Item 7. Major Shareholders
and Related Party Transactions  A. Major Shareholders.

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

| | The
consolidation of our store formats into just three in order to focus our marketing
efforts more effectively and differentiate our store brands;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------

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| | The
increase of the variety of Non-Food and Near-Food items, which
generate more revenues per square meter, with the goal of increasing the portion of our
customers overall shopping needs that are addressed in our stores;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
establishment of a new joint loyalty plan (the YOU Plan) with Dor Alon Energy
In Israel (1988) Ltd., including the offering to our costumers of a new Diners Club
Israel credit card bearing the name YOU, and the acquisition, together with
Dor Alon, of 49% of the shares of Diners Club Israel Ltd., a subsidiary of Credit Cards
for Israel Ltd. (allocated 36.75% to us and 12.25% to Dor Alon) (see Item 4.
Information on The Company  B. Business Overview -Related Businesses); and
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
initial public offering of ordinary shares and convertible and non-convertible unsecured
debentures of our subsidiary, BSRE, on the Tel Aviv Stock Exchange following the transfer
of the Companys real estate assets (including unoccupied land and unused building
rights, but excluding real estate owned by BSIP and its subsidiaries) and certain
liabilities (including lease agreements with third parties and with BSIP) to BSRE (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, 2007, we invested NIS 21.8 million, or $5.2
million, in fixed and other assets. In 2006, we invested NIS 137.4 million, or $32.6
million, in fixed and other assets, a 54.2% increase from our 2005 investment of
NIS 89.1 million. Of our fixed asset investment in 2006, we invested
NIS 21.3 million, or $5 million, in land and buildings, including land that we
lease, as compared with NIS 2.2 million in 2005. In2004, we invested
NIS 89.4 million in fixed and other assets. As of December 31, 2006, we had
entered into agreements for investments in fixtures, equipment and leasehold improvements
in an aggregate of NIS 13.5 million, or $3.2 million.

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

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

# General

We
are the second largest food retailer in the State of Israel. 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
in 2005, we started to operate several toy and housewares departments within most of our
large stores.

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As
of December 31, 2006, we owned and operated 175 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 are BSIP, which has retail activities, and
BSRE, which owns and invests in commercial real estate. As of May 31, 2007, Blue Square
owned 80% of the outstanding shares of BSIP and 80% of the outstanding shares of BSRE, the
balance of each of which is 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 65 of our supermarkets. The consolidated supermarket sales of BSIP and
its subsidiaries in 2006 aggregated approximately 64% of our consolidated supermarket
sales for that period. As of December 31, 2006, the total consolidated assets of BSIP
and its subsidiaries aggregated approximately NIS 1.3 billion, or $304 million,
constituting approximately 31.5% of our total consolidated assets at that date. BSRE has
no retail activities; its revenues are primarily derived from real estate lease payments
received from Blue Square and third parties. As of December 31, 2006, the total
consolidated assets of BSRE aggregated approximately NIS 1.4 billion, or $330 million,
constituting approximately 34.2% 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:

| |                         | No. of Stores | Store Space
(square meters)
| | ----------------------- | ------------- | ---------------------------
|
|
|
|
| | As of December 31, 2002 |               |                            
| | As of December 31, 2003 |               |                            
| | As of December 31, 2004 |               |                            
| | As of December 31, 2005 |               |                            
| | As of December 31, 2006 |               |                            

We
have three store formats  Mega, Super Center and Shefa Shuk. In the Mega
chain stores, our larger stores which are located primarily outside residential areas, we
offer a wide selection of food, Near-Food and Non-Food items. In
the 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. 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, 2006, we operated 39 Mega
Stores, consisting of approximately 160,500 square meters space, 95 Super Center stores,
consisting of approximately 96,200 square meters space, and 41 Shefa Shuk stores,
consisting of approximately 66,600 square meters space.

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In
2005, together with Dor Alon Energy In Israel (1988) Ltd., we established a new loyalty
plan (the Loyalty Plan) which offers our costumers a new Diners Club Israel
credit card bearing the name YOU. The goal of the Loyalty Plan is to promote
customer loyalty to the Company and Dor Alon by, among other things, granting exclusive
benefits to the Loyalty Plan members, such as a cash-based reward mechanism and providing
discounts and benefits at other businesses that join the Loyalty Plan. We also continue to
operate Buy & Bonus and Mega frequent-buyer incentive
programs, which are designed to increase consumer traffic and encourage customers to
patronize our stores and to allow our customers to earn free gifts by earning points. 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
44.3 billion, or $9.9 billion, in 2006. 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 2005 (2006 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
2006 (7.4%).

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 and us, as well as
other smaller but developing chains.

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. Based on A.C. Nielsen and on data
published by the Israeli Central Bureau of Statistics of the retail sales of food, drinks
and tobacco in Israel, we estimate that approximately 39% of the total retail sales of
food, beverages and tobacco in Israel in 2006 was made by the two large chains and
approximately 50% of the estimated retail sales made by supermarkets, groceries and
mini-markets in Israel in 2006 was made by the two large chains  a percentage that
is considerably lower than the estimated market shares prevailing in Europe and the United
States. Accordingly, we believe that there is an opportunity for us to grow
correspondingly with the general growth of the supermarket sector in Israel.

# 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 2006 was 25%.

See
Our Operations for a description of our supermarket formats as of December 31,
2006.

19

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# 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 in our retail activities 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
the pace of our growth rate and market share by opening additional store locations,
renovating, improving and enlarging existing stores and, if necessary, reducing and/or
closing underperforming stores;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | expanding
the geographic presence of our stores with the goal of bringing all three of our store
formats within the shopping range of every Israeli consumer;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 well as toys and housewares;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | exploring
various alternatives to maximize the potential value of our real estate assets, including
unused building rights, which are held by BSIP and its subsidiaries;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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
|- | ----------------------------------------------------------------------------------------------------------------------------------------

| | expanding
and improving our new loyalty plan for the benefit of our customers which offers a new
credit card; including joining other businesses to the plan.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

20

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Our
strategy in our real estate activities is to become a leading owner of income-producing
properties and developer of commercial real estate through our subsidiary, BSRE. As part
of this strategy, in 2006, the Company transferred its real estate assets (excluding real
estate owned by BSIP and its subsidiaries) and certain liabilities to BSRE, and in August
2006 BSRE completed an initial public offering (IPO) on the Tel Aviv Stock Exchange. To
achieve this goal, we intend to pursue a number of operating and growth strategies, which
include:

| | developing
and improving existing real estate;
|- | ----------------------------------------------

| | maximize
the leasing of existing properties to commercial users;
|- | ----------------------------------------------------------------

| | increase
and develop unused building rights in our existing properties;
|- | -----------------------------------------------------------------------

| | maximize
the potential value of our real estate assets; and
|- | -----------------------------------------------------------

| | acquire
additional commercial real estate as deemed appropriate in Israel and abroad.
|- | -------------------------------------------------------------------------------------

# Real Estate

Historically,
most of our real estate was used in connection with the retail operation of our stores.

Transfer
of Real Estate Assets to BSRE

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

Pursuant
to the Transfer Agreement and Split Agreement, Blue Square transferred assets with a total
book value as of December 31, 2005 of approximately NIS 1.1 billion and liabilities with a
total book value as of December 31, 2005 of approximately NIS 759.3 million. In
consideration, BSRE issued to the Company 22,642 ordinary shares.

On
May 4, 2006, the Israeli Tax Authority approved our application for a ruling stating that
the transfer would receive favorable tax treatment under the provisions of Sections 104A
and 105A(2) to the Income Tax Ordinance, subject to certain conditions, as described below
under   Tax Authority Approval.

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

21

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Description
of Transferred Assets and Liabilities

Pursuant
to the Transfer Agreement and the Split Agreement, as of December 31, 2005, the Company
transferred to BSRE approximately 100 properties, totaling approximately 146,300 square
meters. The properties principally consisted of the following:

| |  | 52
supermarkets stores with a total area of 50,500 square meters, which were operated
directly or were, designated to be operated directly by the Company prior to December 31,
2005. Commencing from December 31, 2005, the Company leases these properties from BSRE
under the terms and conditions described below.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 23
supermarkets stores with a total area of 64,500 square meters which prior to December 31,
2005 were leased to BSIP and Hyper Hyper. Together with these stores, the Company also
transferred to BSRE all of the Companys rights and obligations under the leases of
these properties to BSIP and Hyper Hyper.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Additional
built-up properties with a total area of 31,300 square meters, which prior to December
31, 2005, were leased or were for lease to third parties (including Company rights (50%)
in the Hadar shopping mall in Jerusalem and Company holdings (50%) of the issued capital
in the management company of Hadar shopping mall), most of which are for commercial
purposes and some for office use. The lease agreements between the Company and such third
parties were assigned to BSRE, which continues to lease these properties under the same
terms and conditions.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Six
lots of unimproved land with a total area of approximately 17,000 square meters.
| | - | ------------------------------------------------------------------------------------

| |  | The
holding of the Company (3.8%) in the Wholesale Market for Agricultural Production in Tel
Aviv Company, which holds the long-term lease rights in part of the site known as the
Wholesale Market in Tel Aviv. This site has now been designated for commercial, office,
residential and public building use.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Certain
financial obligations to third parties with a book value of approximately NIS 759.3
million as of December 31, 2005, most of which were bank loans. Such financial
obligations included obligations attributed to transferred properties in total sum of
approximately NIS 521.4 million and non-attributable obligations in the total sum of
approximately NIS 237.9 million which constituted 35.1% of the Companys
non-attributable obligations.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

22

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Related
Agreements

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

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

| | Agreements
with Respect to Properties Operated by the Company.
| | --------------------------------------------------------------

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

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

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

23

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

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

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

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

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

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

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

24

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

In
addition, the Company and BSRE entered into the following additional agreements: (i) a
service agreement according to which the Company will provide certain services to BSRE;
(ii) agreement with respect to the allocation of various insurance expenses; (iii)
agreement with respect to transfer of employees from the Company to BSRE; and (iv)
agreement with respect to deposit of cash balances.For more
information about the agreements between the Company and BSRE, see Item 7. Major
Shareholders and Related Party Transactions  B. Related Party Transactions.

Tax
Authority Approval

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

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

A
breach of the conditions set forth in the Israeli Tax Authoritys approval and the
related provisions of the Israeli Income Tax Ordinance may result in the Company being
charged with capital gains or betterment tax and sales tax, and BSRE being charged for the
full rate (5%) of purchase tax (and stamp tax, if applicable). Conditions of the Israeli
Tax Authority ruling included the following:

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

25

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

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

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

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

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

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

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

26

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In
accordance with the Israeli Tax Ordinance, the construction of buildings on unimproved
land transferred to BSRE must be completed within four years of transfer. To the extent
this construction is not be completed within this four year period, the Company and BSRE
may approach the Tax Authority for their determination as to whether such delay
constituted a default for purposes of the tax benefits.

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, low-priced private supermarket chains and low-price 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.

Based
on A.C. Nielsen, we estimate that our market share of the bar-coded market in Israel in
2006 was approximately 25%, Super Sols market share of the bar-coded market in
Israel in 2006 was approximately 37.7%, and the private supermarkets market share of
the bar-coded market in Israel in 2006 was approximately 24.5%.

In
recent years, we and our competitors have established or expanded low-price and hard
discount store formats. In addition, private supermarkets during 2006 increased their
market share andexpanded their presence in selected areas in Israel, often
geographically beyond their original locations. The low barriers of entry, including the
relatively low cost of establishing a new private supermarket, have contributed to the
increase in number and expansion of private supermarkets in recent years. 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.

Super
Sol, the other major supermarket chain, has taken numerous initiatives in the last few
years to improve its competitive position. During 2005, Super Sol merged with ClubMarket
following the bankruptcy proceedings of ClubMarket, the then third major supermarket
chain. As a result of such merger, we now face a major competitor, with a broader national
presence, especially in the northern part of Israel where many of ClubMarket stores were
located. Many of Super Sols stores are characterized by every day sale of products
at low prices. During 2006, in addition to expanding one of its hard-discount store
formats, Super Sol completed the consolidation of its store formats, re-branded its store
formats to compete directly with our store formats (including a new format for the
ultra-orthodox population), launched a Super Sol credit card in a joint venture with
Leumi-Card Ltd. and Paz Oil Company Ltd., and began selling its own line of private label
products. These initiatives by Super Sol, together with the expansion of private
supermarkets in recent years, have contributed to the intensifiedcompetition we
experiencedin 2006, particularly at our larger stores.

27

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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
was expected to perform the following actions for its Members: to develop and market a
private label which shall be marketed exclusively in the Member stores; to purchase for
the Members complementary services and products; to negotiate with suppliers from abroad
for the import of products for the Members and, in a later stage, to negotiate prices and
commercial conditions with suppliers; to operate a central joint warehouse; and to sell
products to retails other than its Members. The aforesaid arrangement, and possible
similar combinations of other private supermarkets, may generate some of the efficiencies
of a major national-spread chain and therefore enable them to compete more efficiently
with the major chains. In 2006, the Fourth Chain Company started to market a private label
brand.

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 sale of other Near-Food and Non-Food
products, we compete against retail chains and stores outside the food industry, such as
Toys R Us, Office Depot, do-it-yourself chains such as Home Center and ACE (a
franchisee of Ace Hardware), household stores 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.

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 operate several toy and housewares departments within most
of our large stores. In addition, we sell over the counter pharmaceutical medical
products.

28

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A
portion of our stores operations is owned directly by the Company, and the other portion
is owned by Blue Squares subsidiary, BSIP and its subsidiaries. The stores which are
owned directly by the Company 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.
The Company leases the real estate underlying the stores that it directly operates from
BSRE, BSIP and third parties.

The
following table provides certain information regarding the Blue Square stores and the BSIP
stores as of December 31, 2006:

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

(1) Large stores (average size of approximately 4,100 square meters),
          primarily located outside residential areas, offering a wide selection of food
          items and other departments.

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

(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.

29

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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 81.2% of our grocery items and
90.6% of our meat and fish are delivered directly by suppliers to some of our stores. For
certain other items, including 79% (in 2006) of fruits and vegetables, we provide
distribution to our supermarkets through our distribution center. For the year ended
December 31, 2006, approximately 23% of our purchases were of products distributed
from the distribution center.

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 2006 Tnuvas products
accounted for approximately 13% of all the products sold at our supermarkets. In addition,
the Strauss group, an Israeli food manufacturer, accounted for approximately 9.5% of all
products sold at our supermarkets in 2006, and the Osem group accounted for approximately
6.6% of all products sold at our supermarkets in 2006. Because of our status as a leading
food retailer in Israel and the fact that we maintain an excellent and long-standing
relationship with Tnuva, Strauss group and Osem, we do not believe that there is a
material risk of future stoppage of supply of products of these key suppliers. However, we
do not have a written contract with Tnuva, Strauss group or Osem obligating them to supply
products to us. In addition, in recent years, there has been a process of consolidation
among our suppliers. As a result, our largest suppliers now account for a larger
percentage of our product purchasers. The ten largest suppliers for our supermarkets
accounted for approximately 51.2% of our product purchases in 2006. 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, internet,
billboards and direct mail. Store promotions are conducted, from time to time, in all our
supermarkets, in specific chains or in individual stores. These promotions include our new
Loyalty Plan  YOU, Mega club, Buy & Bonus incentive program, price
reductions, gifts, coupons or deferred payment terms.

In
2005, together with Dor Alon Energy In Israel (1988) Ltd., we established our new Loyalty
Plan  YOU, which was launched in the second half of 2006 and offers to our customers
a new Diners Club Israel credit card bearing the name YOU.

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The
goal of the Loyalty Plan is to promote customer loyalty to the Company and Dor Alon by,
among other things, granting exclusive benefits to the Loyalty Plan members, including
establishing a cash-based reward mechanism, and providing discounts and benefits at other
businesses that would join the Loyalty Plan. In addition, through the Loyalty Plan the
Company may provide other services such of personal finance, insurance products and
tourisms packages. We also continue to operate Buy & Bonus and
Mega which are frequent-buyer incentive programs, and which are designed 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.

We
have joint advertising and sales initiatives together with some of our suppliers. The
stores accept cash, checks, credit cards, gift certificates and prepaid electronic cards.

During
the High Holiday and Passover seasons, we run gift certificates programs, under which we
issue and sell gift certificates and prepaid cards to institutions, companies and
individuals. The gift certificates and the prepaid cards can be used in our stores as well
as other stores with which we entered into collaboration agreements. We also participate
in tenders in connection with the sale of our gift certificates and prepaid cards. From
time to time, we also operate joint marketing promotions with other entities.

In
addition, we operate the Blue Center website which allows customers to place orders via
the Internet 24 hours a day and to have the products in our stores delivered to our
customers homes from a nearby store within a few hours. Likewise, customers may
order products by phone (through a calling center) or by fax. We endeavor to keep the
website up to date with the same discounts that are available at our Super Center stores.
The service is provided (through 15 centers located at Mega stores), in most of Israel.

# 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.

The
Israeli government is authorized to control the retail and wholesale prices of goods and
services offered in Israel. At present, a few of the products we offer in our stores,
including bread, flour, eggs, milk and margarine are subject to government-imposed price
controls. In 2006, a new requirement was imposed requiring bread suppliers to sell certain
standard bread to retailers, such as the Company, at certain fixed prices. 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 standard 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.

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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.

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 this 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.

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.

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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
standard commission rate to all food establishments was set. In 2006, following a decision
by the Restrictive Trade Practices Court affirming the position of the Antitrust Authority
regarding the methodology for calculating the interchange commission rates, the credit
card companies and the Commissioner of the Antitrust Authority reached a long-term
arrangement providing for, among other things, the gradual reduction in the interchange
commissions as well as the gradual reduction in the number of interchange commissions
categories for businesses from four to just two. This agreement was submitted for the
approval of the Restrictive Trade Practices Court. To the Companys knowledge, some
of the credit card companies have filed an appeal with the Israeli Supreme Court
challenging the decision of Restrictive Trade Practices Court referred to above.

Arrangements
between Major Supermarkets Chains and Large Suppliers

From
April 2000 to May 2003, the Israeli Antitrust Authority conducted an investigation into
alleged restrictive trade arrangements between major supermarkets chains in Israel and
large suppliers. During the investigation, an inquiry was conducted in our offices and our
former CEO and other senior officers were questioned.

On
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 the antitrust
authorities. 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.

In
August 2006, the Restrictive Trade Practices Court approved a consent decree reached
between the Commissioner and certain food suppliers. The consent decree is directed at the
food suppliers listed therein and stipulates various prohibitions, conditions and
restrictions that apply to these suppliers with regard to certain practices. The consent
decree addresses the following arrangements:

| |  | Reduction
in the number of suppliers. 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Acquisition
of shelf and off-shelf display space. A dominant supplier is prohibited to be a part
of: (i) an arrangement granting an allocation exceeding half of the overall display area
designated for the product category in which he has dominance; (ii) an arrangement which
its purpose or effect is granting exclusivity to one or more of the suppliers
products in an off-shelf display in which it has dominance (nevertheless, exclusive
arrangement for off-shelf display for a limited discount period will not constitute a
basis for enforcement measures under certain circumstances). In addition, arrangements
with suppliers (as opposed to dominant suppliers) regarding allocation of shelf area or
off-shelf display, if not prohibited according to the decree, may not exceed a period of
one year (the retail chain and the supplier may enter a new arrangement at the end of the
one year term, provided the period of such new arrangement does not exceed one year and
is in accordance with the provisions of the decree).
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Category
management: Unless prior approval of the antitrust authorities is obtained, a
dominant supplier is prohibited to be party to an arrangement whose purpose or effect is
the supplier involvement (including as advisor) in the process of category management
(nevertheless, a retail chain may consult with a supplier regarding innovations in this
area).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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. As of the date of this Annual Report, the
Company has begun the necessary preparations to arrange on its own the shelves in its
stores.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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| |  | Price
dictation by supplier. A supplier is prohibited from setting the consumer price of
its products sold in the chain and from intervening in chain decisions regarding the
setting of the consumer price of its products or of its competitors products.
Nevertheless, a supplier may recommend the resale consumer price of its products to the
chain, provided that the supplier takes no action to enforce such recommendation.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
consent decree clarifies that nothing in the provisions contained therein prevents the
chain from allocating shelf space at its own independent discretion, even if such
allocation exceeds half the available shelf space, so long as there is no involvement or
interference from the supplier and so long as there is no prior coordination or
understanding with said supplier.

The
Company is not a party to the consent decree; however, it could nevertheless have an
effect on the practices of the Companys suppliers and indirectly on the Company.

Consumer
Protection Laws

We
are obligated to label prices on our products on the basis of two main laws: The
Consumer Protection Law, 1981, and the Commodities and Services (Control)
Law, 1957. Contravention of these laws constitutes a criminal offense. Under proposed
regulations, we will be obligated to indicate on the shelf the price per measurement unit
with respect to various products. Such proposed regulations, if enacted, would impose on
us additional costs and could increase the risk for discrepancies between the prices that
appear on the products, the prices that appear on the shelf and the prices charged by the
cash register. In 2006, we were indicted in connection with discrepancies between the
prices appearing on products, and the prices charged by the cash register at the point of
sale. These discrepancies are the result of human error by personnel responsible for
labeling our products and other circumstances beyond the Companys control. We are
making 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 do not believe that such
indictment will have a material adverse effect on our business.

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.

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In
addition, under the Consumer Protection Law, we are obligated to post our
merchandise return policy in our stores. The law and regulations promulgated thereunder
impose various requirements regarding the location, details, size and shape of the notice
of such policy. Under a recently proposed consumer protectionregulation, a seller
would be obligated to refund the payment received from a consumer in the event the
consumer cancels the transaction within 21 days from the purchase date so long as the
goods are returned unused and without defects. This proposed regulation would apply under
various conditions to various Non-Food and Near-Food products, but would not apply to food
products.

In
February 2006, new regulations were promulgated under the Consumer Protection Law,
which regulate 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 regulations became effective as of September 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 $23,500)
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.

Under
a recent proposed amendment to the Consumer Protection Law, 1981, a remedy of
exemplary (punitive) damages may be provided to plaintiffs for specific violations of the
law under certain circumstances. By virtue of the proposed amendment, the court may grant
an amount of no more than of NIS 10,000 (approximately $2,350) in punitive damages and an
amount exceeding NIS 10,000 but no more than NIS 100,000 (approximately $23,500) if the
court finds that the violation is a repeat or continuing
violation. As of the date of this Annual Report, we cannot assess the effect of this
proposed amendment.

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Recently,
a private bill (proposed legislation), Paper Bag Package Obligation,
was submitted to the Knesset pursuant to which a food retail chain will be
required to provide its consumers, free of charge, paper bags to package the products
acquired at the retail chain. The retail food chains would be forbidden from possessing
any other kind of bags for packaging purposes and from providing consumers with any other
bag for any use. Breach of this law would constitute a criminal offense penalized by fine.
We currently use and provide to our consumers, free of charge, plastic (nylon) packing
bags.

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.

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, maximum selling quotas to individual consumers and requirements relating to the
size, composition, sanitation, temperature and safety of the stores selling OTC drugs.

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), some
existing requirements will be tightened and new requirements will be imposed on the
operation of our stores. The new regulation would contain new or more stringent
requirements relating to the following: requirements as to the building of our stores,
designation of separated space to some specialty departments, drainage system
requirements, sanitation, ventilation, lighting, temperature, water, sewage, waste
handling, food storage, signage, food transportation and maintenance requirements, cooling
device requirements and display and quality requirements. This proposed new Business
License Regulation, would require us to make additional investments in our stores if
it were to become effective.

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Gasoline
Stations

We
are also subject to numerous laws and regulations relating to, among other things,
environment protection, licensing and permits proceedings, standardization requirements
and other requirements in connection with the construction, establishment and operation of
gasoline stations on our properties described below in Item 4. Information on the
Company  D. Property, Plants and Equipment. As part of a pilot program to
examine the feasibility of establishing and operating gasoline stations on properties
adjacent to our stores, in 2006, we began operating our first gasoline station on one of
our properties. We have applied for a business license for the operation of this gasoline
station, but the business license has not yet been granted.

# Related Businesses

Hamachsan
Hamerkazi Kfar Hashaashuim Ltd. (Central Warehouse/Toy Village)

As
part of our strategy to increase our market share of Non-Food and
Near-Food products and to offer a wider selection of these products to
consumers in our stores, in May 2005, we acquired 50% of the holdings of Hamachsan
Hamerkazi Kfar Hashaashuim Ltd. (Central Warehouse/Toy Village) and in April
2007, we increased to 60% our holdings in Central Warehouse/Toy Village.

Central
Warehouse/Toy Village is Israels largest franchiser of All for a Dollar,
toy and houseware stores, with 183 stores owned and operated by franchisees. The chain
operates under four different brand names: (i) All for a Dollar; (ii)
Kfar Hashaashuim (Toy Village), which sells toys; (iii)
Sheshet, which sells housewares and small electrical appliances, and (iv)
Rav-Kat, which sells baby and young children accessories. In addition to these
stores, we have established toy and houseware departments within most of our large stores.

In
April 22, 2007, Central Warehouse/Toy Village acquired approximately 86% of the share
capital of Vardinon Textile Ltd. (Vardinon) a company traded on the Tel Aviv
Stock Exchange for a total consideration of approximately NIS 37 million. Vardinon
imports, designs and distributes home textile products and accompanying accessories, such
as linen, towels and bathrobes under the brand name Vardinon and other
products such as blankets, bed covers, curtains, pillows, other houseware products,
candles and spa products. The products are distributed by Vardinons chain of 29
stores and through other channels.

Diners
Israel

In
connection with the establishment of our new joint Loyalty Plan with Dor Alon Energy In
Israel (1988) Ltd. (Dor Alon), on November 29, 2005, we and Dor Alon purchased
49% of the shares of capital stock of Diners Club Israel Ltd. (Diners Israel)
(36.75% to Blue Square and 12.25% to Dor Alon) from Credit Cards for Israel Ltd.
(CAL). Diners Israel, a credit card company in Israel and a licensee of Diners
Club International, is a subsidiary of CAL which itself is a subsidiary of Israel Discount
Bank Ltd.

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Under
the agreement with CAL, we and Dor Alon are entitled to share with CAL the net income of
Diners Israel in connection with the activities of the credit cards bearing the
YOU name based on our respective ownership interests in Diners Israel. The
percentage of the net income of Diners Israel in connection with credit cards activities
outside the Loyalty Plan is to be allocated to us and to Dor Alon in accordance with
various ratios determined based on the number of activated credit cards (as
defined in the agreement) issued to members of the Loyalty Plan from time to time, so long
as certain target numbers of such issued credit cards are met. See Item 7. Major
Shareholders and Related Party Transactions  B. Related Party Transactions for
more information on the agreement with CAL and Diners Israel.

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

We
operate all of the supermarkets, including 110 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 64% of our
supermarket sales during 2006. The Company leases the real estate underlying the stores
that it directly operates from BSRE, BSIP and third parties.

BSRE,
BSIP and each of BSIP 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 and BSRE, which are publicly
traded on the Tel Aviv Stock Exchange, the board of directors must include at least two
external directors appointed under Israeli law. These external directors must satisfy all
the requirements of external directors under the Israeli Companies Law, 1999, referred to
as the Israeli Companies Law.

Blue
Square owned approximately 80% of the outstanding shares of BSIP as of December 31,
2006. 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.

Blue
Square owned approximately 80% of the outstanding shares of BSRE as of December 31,
2006. The balance of BSREs outstanding shares are publicly held and traded on the
Tel Aviv Stock Exchange. Blue Square receives fees from BSRE as payment for the management
services it provides to it for Chairman of the board of directors services, financial and
accounting management services (including bookkeeping), computer management and
maintenance service, legal consulting and corporate secretary services, office space and
related office services, and internal audit services.

41

---

---



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

The
shares of BSIP are currently included on the Tel Aviv Stock Exchange 100 Index (Tel Aviv
100 (TA100) Index), which generally represents the 100 shares traded on the Tel Aviv Stock
Exchange (TASE) with the largest market value (subject to a minimum volume
requirement).  Proposed new TASE rules would require that the public hold at least
25% of any shares listed on the TASE 100. As of May 31, 2007, Blue Square held 80% of the
outstanding shares of BSIP. In the event the proposed TASE rules are adopted and Blue
Squares holdings in BSIP remain the same, then BSIP shares will be removed from the
TASE 100.

Set
forth below is a list of our significant holdings as of May 31, 2007. The companies marked
with an asterisk (*) are not consolidated in our financial statements.

|Company(1)                                          | Operations | % Ownership Held by
Blue Square
|--------------------------------------------------- | ---------- | -------------------------------
|
|
|
|
|The Blue Square Chain Investments & Properties Ltd. |            |                                
|The Blue Square Chain (Hyper Hyper) Ltd.            |            |                                
|Blue Square Real Estate Ltd.+                       |            |                                
|Hamachsan Hamerkazi Kfar Hasha'ashuim Ltd(5)        |            |                                
|Diners Club Israel Ltd.*                            |            |                                
|Radio Non Stop Ltd.*                                |            |                                

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

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

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

| | (4) | The
remaining shares of BSRE are held by the public and institutional investors
               and traded on the Tel Aviv Stock Exchange.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------

| | (5) | Hamachsan
Hamerkazi Kfar Hashaashuim Ltd. holds approximately 85.8%                interest
in Vardinon Textile Ltd., a company traded on the Tel Aviv Stock                Exchange.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (6) | The
remaining shares of Diners Club Israel Ltd are held by Credit Cards for
               Israel Ltd. (51%), a subsidiary of Israel Discount Bank Ltd., and by Dor
Alon                Energy In Israel (1988) Ltd. (12.25%) (through a subsidiary). As of
the date of                this Annual Report, the right of the Company to participate in
the income of                Diners Club Israel in connection with credit card activities
outside the Loyalty                Plan is subject to the satisfaction of various
conditions. See Item 7.                Major Shareholders and Related Party
Transactions  B. Related Party                Transactions for information
with respect to our rights as a shareholder                of Diners Israel.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

42

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| | (7) | Hyper
Hyper holds its interest in this company through a wholly owned
               subsidiary, which holds a 33% equity interest in Radio Non-Stop Ltd. The
               remaining interests are held by unaffiliated entities.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | +
Including also a 50% interest in a 17,000 square meter shopping mall in Jerusalem owned
by BSRE.
| | --------------------------------------------------------------------------------------------------

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

As
of December 31, 2006 we owned or leased (including through our subsidiaries)
approximately 323,304 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 BSRE in a 17,000 square meter shopping mall           in
Jerusalem, in which we operate a 5,000 square meter store.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------

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

43

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In
2007, we opened and plan to open approximately eight to ten additional supermarkets,
totaling approximately 18,000  25,000 square meters of store space, in localities
whose populations are currently under-served by supermarkets or in localities in which we
do not have sufficient market presence.UntilMay 31, 2007, we opened four
supermarkets stores. 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 140 million, or $33 million, on the acquisition and development
of new supermarkets and the remodeling of our existing supermarkets through the end of
2007.

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

For
further information regarding our real estate, including the transfer of the
Companys real estate to BSRE, please see Item 4. Information on The Company
 B. Business Overview  Real Estate.

|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 2006 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 and increase in our efficiency.

44

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---



We
believe that an important factor in the purchase decisions of a large portion of the
Israeli public is the price of the products it purchases. At the same time, during the
last two years, there has been an increase in sales made by the local neighborhoods and
city centers stores (which have less of a focus on discount prices). Such increase may
suggest that, for a portion of the consumer market, there has been a change in their
buying patterns, i.e., preferring convenience and geographical proximity to the
lower prices of supermarket stores. On the other hand, in 2006 we saw intensifiedcompetition at our larger stores due to the expansion of private supermarkets in
recent years, as described below, as well as due to recent initiatives by Super Sol to
improve its competitive position.

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 and 2006 by increases to our regional sales volumes.

During
2006, private supermarkets increased their market share and expanded their presence in
selected areas in Israel, often geographically beyond their original locations, increasing
competition in an already difficult market. The low barriers of entry, including the
relatively low cost of establishing a new private supermarket, have contributed to the
increase in number and expansion of private supermarkets in recent years. 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 focus on the price of products by establishing or expanding low-price and
hard discount store formats.

We
are increasing the variety of products sold in our stores in three categories: Fresh
Food items  such as bakery items, delicatessen, pastry, fresh meat and
vegetables offered in specialty departments, Non-Food items  such as
housewares, toys, entertainment and leisure products, small electrical appliances,
computers and computers accessories and textile products, and Near-Food items
 such as health and beauty aids, toiletries, cleaning products, paper goods and baby
supplies. We are also looking to also provide a diversified range of insurance, financial
and tourism products to our customers to further increase the variety of products we offer
to our customers.

We
have increased and plan to continue increasing our investments in our Fresh
Food specialty departments and the establishment of these departments in additional
stores. Non-Food and Near-Food items generate more revenues per
square meter than our food items and increase the portion of our customers shopping
needs that are addressed in our 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, and in April 2007 we increased to 60% our holdings
of Central Warehouse/Toy Village. In April 2007, we acquired, through Central
Warehouse/Toy Village, approximately 86% of the holdings of Vardinon Textile Ltd., a
company which imports, designs and distributes home textile products and accompanying
accessories. In addition, we sell over the counter pharmaceutical medical products to
further expand the mix of goods sold in our stores.

45

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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                                       |                        

Year Ended December 31, 2006 compared
with year ended December 31, 2005

Sales. Sales
in 2006 were approximately NIS 6,515 million, or $1,542 million, an increase of
approximately 12.4% (10.2% excluding sales by Kfar Hashaashuim) compared with sales of
approximately NIS 5,797 million in 2005. The growth in sales derived from:

| |  | Success
of the Companys brand management strategies, including the restructuring of
operations into three brands, the identification of the return to the neighborhood trend
and the strengthening of discount brands. As a result, Same Store Sales increased by 5.3%
as compared with 2005;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ongoing
expansion, including the opening of seven stores during the year, increasing the Companys
sales area by approximately 11,304 square meters, and renovations carried out throughout
the chain;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Successful
marketing, including pricing policies and attractive special offers;
| | - | -------------------------------------------------------------------------------

| |  | The
strengthening of Israel's economy and the reduction in unemployment; and
| | - | ----------------------------------------------------------------------------

| |  | The
consolidation of the financial results of Kfar Hashaashuim into the Companys
consolidated financial results for the entire 2006, as compared to consolidation of Kfar
Hashaashuims financial results into the Companys consolidated financial
results for only the second half of 2005.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

46

---

---



Gross
profit. Gross profit in 2006 was approximately NIS 1,702.1 million, or $402.9 million,
an increase of 13.6% compared with gross profit of approximately NIS 1,498.8 million in
2005. This increase in gross profit was due to higher revenues, pricing policies and
improved supplier contract conditions. As a result the gross margin for 2006 increased to
26.1% from 25.9% in 2005.

Selling,
general and administrative expenses. Selling, generaland administrative
expenses in 2006 were approximately NIS 1,396.9 million, or $330.6 million, an increase of
10% compared with selling, generaland administrative expenses of approximately NIS
1,269.8 million in 2005. This increase reflected:

| |  | Expenses
related to the opening of new stores during the year;
| | - | --------------------------------------------------------------

| |  | An
 increase  in employee  wages  resulting  from,  among  other  things,  an increase in
the                   minimum wage; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| |  | Expenses
related to the launch of the Companys YOU loyalty plan.
| | - | -------------------------------------------------------------------

However,
this was moderated by a decrease in a variety of other expenses as a result of ongoing
increase in our operational efficiency, enabling the Company to decrease its operating
expenses as a percentage of revenues to 21.4% of sales from 21.9% in 2005.

Operating
income. Operating income in 2006 was approximately NIS 305.2 million, or $72.2
million, an increase of 33.3% compared with approximately NIS 229 million in 2005,
resulting in an operating margin for the year of 4.7% compared to 4.0% in 2005. The
increase in operating income reflected the increased gross profit for the period, offset
by the moderate increase in selling, general and administrative expenses.

Financial
expenses, net. Financial expenses, net in 2006, declined by 28.8% to approximately NIS
42.4 million, or $10 million, compared with financial expenses of approximately NIS 59.5
million in 2005. This change reflected:

| |  | The
effect of the years negative inflation of 0.29% on the CPI index known at the end
of the year (hereinafter: Known CPI index), which decreased the financial
expenses associated with its index-linked loans and debentures, compared with a 2.69%
increase in the Known CPI index in 2005; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Reduction
in average level of debt due to the initial public offering of the BSRE in August 2006.
| | - | -------------------------------------------------------------------------------------------------

Other
income, net. Other income, net in 2006 was approximately NIS 78.0 million, or $18.5
million, compared with other income, net of approximately NIS 0.7 million in 2005. The
2006 other income consisted primarily of the following:

47

---

---



| |  | A
capital gain of approximately NIS 49 million recorded in the third quarter as a result of
the IPO of BSRE in August 2006;
| | - | ---------------------------------------------------------------------------------------------------------------------------

| |  | Non-cash
income of approximately NIS 23 million recorded following the Companys review of
the carrying value of its assets in compliance with Israeli Accounting Standard No.15
 Impairment of Assets. The Company recorded a reversal of the impairment provisions
due to the increase in the value of the Companys properties and stores in light of
the strengthening of the local real estate market, together with the Companys
increased sales and profitability.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | A
capital gain of approximately NIS 6 million recorded in the fourth quarter, reflecting
the sale to the public of 0.73% of the shares of BSIP, a transaction undertaken to assure
that the shares of BSIP would continue to be included in the Tel Aviv 100 (TA100) Index;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Taxes
on income. Taxes on income in 2006 were NIS 96.7 million, or $22.9 million, compared
with approximately NIS 58.5 million in 2005. As a percentage of income before taxes on
income, taxes on income decreased to approximately 28.4% in 2006, compared with 35.7% in
2005. The reduction was due to a capital gain arising from the IPO of BSRE, which was not
taken into account in computing tax expenses as it is the Companys policy to hold
this investment and not to realize it. In addition, the Companys nominal tax rate
has been reduced in accordance with amendments to the Income Tax Ordinance enacted in July
2004 and August 2005. These amendments provide for a gradual reduction in the rate of
corporate tax. For further information, see Item 5. Operating and Financial Review
and Prospects  Corporate Tax Rate below.

Minority
interest in profit of subsidiaries, net.Minority interest in profit of
subsidiaries, net in 2006 was approximately NIS 31.6 million, or $7.5 million, an increase
of 100.9% compared with approximately NIS 15.7 million in 2005. This increase in minority
interest in profit of subsidiaries, net, was primarily attributable to the initial public
offering of BSRE.

Net
income. Net income in 2006 increased by 137.7% to NIS 213.9 million, or $50.6 million
(NIS 5.46 or $1.29 per ADS) (NIS 4.92 per fully diluted ADS), compared with a net income
of approximately NIS 90 million in 2005 (NIS 2.32 per ADS) (NIS 2.26 per fully diluted
ADS).

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

For purposes of the comparison of the
financial results for 2005 with the financial results for 2004, figures in U.S. dollars
arebased on the representative exchange rate between the NIS and the dollar as
published by the Bank of Israel for December 31, 2005.

Sales. Sales
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:

48

---

---



| |  | 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
| | - | ---------------------------------------------------------------------------------------

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

49

---

---



| |  | 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:

| |  | 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 a
former                   investee company of the Company; 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
Israeli Accounting Standard No. 15 (Impairment of Assets), and the closure of stores;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

50

---

---



| |  | 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.
For further information, see Item 5. Operating and Financial Review and Prospects
 Corporate Tax Rate below.

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).

# 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.

51

---

---



The
following table sets forth certain quarterly information.

|               | Net sales | Operating income
|-------------- | --------- | ----------------
|
|
|
|
|2006           |           |                 
|First quarter  |           |                 
|Second quarter |           |                 
|Third quarter  |           |                 
|Fourth quarter |           |                 
|               |           |                 
|2005           |           |                 
|First quarter  |           |                 
|Second quarter |           |                 
|Third quarter  |           |                 
|Fourth quarter |           |                 

# Exchange Rates

At
December 31, 2006, the representative rate of exchange of the NIS to the dollar, as
published by the Bank of Israel, was NIS 4.225 = $1.00.At May 31, 2007, the
representative rate of exchange of the NIS to the dollar, as published by the Bank of
Israel, was NIS 4.033 = $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, 2002
through 2006:

|Year Ended
December 31, | Period End | Average Rate(1) | High | Low 
|----------------------- | ---------- | --------------- | ---- | ----
|
|
|
|
|                        | 2002       |                 |      | 4.74
|                        | 2003       |                 |      | 4.38
|                        | 2004       |                 |      | 4.31
|                        | 2005       |                 |      | 4.60
|                        | 2006       |                 |      | 4.30

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

(2)    
          During 2006, the US dollar depreciated in value vis-à-vis the NIS by 8.2%

The
following table sets forth certain information concerning the representative exchange rate
of the NIS to the dollar, as published for the months December 2006 through May 2007:

|Month    | Period End | Average Rate(1) | High | Low 
|-------- | ---------- | --------------- | ---- | ----
|
|
|
|
|December |            |                 |      | 4.23
|January  |            |                 |      | 4.26
|February |            |                 |      | 4.21
|March    |            |                 |      | 4.12
|April    |            |                 |      | 4.02
|May      |            |                 |      | 4.03

(1)    
          The average of the daily exchange rates.

52

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Impact
of Inflation and Currency Fluctuations

Inflation
in Israel increases some of our expenses, which, because of competitive pressures, are
generally not offset, fully or as quickly, by increases in our selling prices and
revenues. In recent years, inflation in Israel has been low. The low inflation rate has
not led to increases in the portion of our operating expenses linked to the Israeli CPI or
to an increase in our finance expenses, most of which are linked to the Israeli CPI.

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 to us.
However, the amount of goods imported by us is not material compared with our overall
purchases of goods. An increase in price of imported goods by our suppliers can usually be
offset by an increase in the consumer price of such goods.

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

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 Boards. 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 July 2006, a
conflict with Hezbollah escalated significantly on Israels northern border. This
conflict included the firing of multiple rockets by Hezbollah throughout northern Israel
as well as retaliatory attacks by Israel throughout Lebanon. These hostilities have seen
ceased. The future effect of the continuance of these hostilities on the Israeli economy
and our operations is unclear.

53

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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.

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 supermarket 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 2005 and 2006,
it rose by 1.5%, 4.8%, 5.2% and 5.1%, respectively. The economic slowdown during 2001,
2002 and a portion of 2003 adversely affected our financial performance. Initial reports
indicate that the Israeli economy grew by 6.3% at the first quarter of 2007. We cannot be
sure how any growth or decline in the Israeli economy will affect our financial
performance. According to a recent forecast by the Bank of Israel, the growth in the
Israeli economy will continue in 2007 and 2008 and the Israels Gross Domestic
Product will rise by 4.6% in 2007 and by 4.8% in 2008.

# 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.

54

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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 29% of our taxable income in 2007 (31%
in 2006).

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 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.

55

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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.
Goodwill is principally allocated to the operations of the Companys principal
consolidated subsidiary, BSIP. Pursuant to Israeli Accounting Standard No. 20 of the
Israel Accounting Standard Boards, which the Company has applied since January 1, 2006,
goodwill and certain intangible assets must be tested for impairment at least annually.

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.

56

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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.

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 actuary, who makes estimates based on variety of factors,
including retirement age and interest rates.

Tax
Uncertainties

The
 provisions  for tax  exposures in our  financial  statements  are  determind by the
Company  based on advice we receive from legal counsel as to eatimated tax exposure.

Critical
Accounting Policies

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

57

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Revenue
recognition

Commencing
January 1, 2006, the Company applies Israeli Accounting Standard No. 25 of the
Israel Accounting Standard Boards  Revenue, which 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).

Revenue
is measured, as detailed below, at the fair value of the consideration received or the
consideration that the Company is entitled to receive, taking into account trade discounts
and/or bulk discounts granted by the entity. Revenue from sale of goods is 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.

Revenue
from the 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 the Company to fulfill its performance obligations, based
on the Companys experience.

Discounts,
including those relating to gift certificates, are recognized as a reduction of sales upon
occurrence of the related sales.

Upon
the application of the Standard, the Company separates the financing component embedded in
revenue from sales made on credit for periods exceeding the customary credit period in its
industry (approximately 90 days), that does not bear interest at the appropriate rate.
Revenue from the financing component is recognized over the credit period. Through
December 31, 2005, the Company did not separate the financing component in respect of
sales made on credit, as above, and included within revenue from the sale on the date of
recognition of such revenue.

The
cumulative effect of the application of the Standard as of January 1, 2006 and for the year 2006 is
immaterial.

Deferred
taxes

Effective
January 1, 2005, the Company applied Israeli Accounting Standard No. 19 of the Israel
Accounting Standard Boards  Taxes on Income that prescribes the
accounting treatment (recognition criteria, measurement, presentation and disclosure)
required for taxes on income.

58

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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.

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.

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 of our financial statements.

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.

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 taxes in respect of transactions that
are recognized directly in shareholders equity (in such instances, the applicable
tax is taken directly to shareholders equity).

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.

Goodwill

Prior
to January 1, 2006 under Israeli GAAP, goodwill was amortized in equal annual installments
over a period of 10 and 20 years and reviewed for impairment when circumstances indicated
the possibility that impairment exists. Commencing January 1, 2006, under an amendment to
Israeli Accounting Standard No. 20, goodwill is no longer amortized and is tested for
impairment at least annually.

59

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Under
U.S. GAAP, goodwill is not amortized. In addition, 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
BSIP, 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.

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 2x 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, BSRE and their subsidiaries have historically been used, and are
expected to continue to be used, to finance the expansion of these companies.

Cash
generated by operations was approximately NIS 270 million in 2006, an increase of 29%
compared with approximately NIS 210 million in 2005. This increase in cash generated by
operations in 2006 was mainly due to an increase in the net profit not taking into account
non-cash income of approximately NIS 78 million (resulting from the initial public
offering of BSRE and from a reversal of the impairment provision of the Companys
assets in compliance with Israeli Accounting Standard No.15  Impairment of Assets).

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:

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

In
2006,  approximately  35.9% of our supermarket
sales were paid for with cash,  checks and gift certificates  issued by the Company at the  point-of-sale,
approximately  61.1% of  supermarket  sales  were paid for with  credit  cards and  approximately  1.2% of
supermarket sales were paid for with other short-term credit arrangements.

60

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During
2006, the average time period that we held inventory was 28 days and the average time
period within which our accounts receivable were paid was 29 days. By contrast, as of such
date the average time period for payment of our accounts payable was 59 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 2006, we
received long-term borrowings of NIS 54.7 million, or $12.9 million.

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

During
2006, we repaid NIS 5.2 million, or $1.2 million, in short-term borrowings and NIS 809.2
million, or $191.5 million, in long-term borrowings (which amount included repayment of
NIS 518 million, or $122.6 million repaid from the proceeds of the issuance of BSRE
debentures, refer to in the previous paragraph).

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
2006, we invested approximately NIS 137.4 million, or $32.5 million, in fixed and other
assets, in the development of new stores and in existing store renovation and remodeling,
an increase of 54.2% compared with approximately NIS 89.1 million during 2005 which, in
turn, represented a decrease of 0.4% compared with approximately NIS 89.4 million during
2004. We currently plan to spend in excess of NIS 165 million, or $39 million for the
development or acquisition of new supermarkets, the renovation and remodeling of our
existing supermarkets and related investments through the end of 2007. We intend to
finance our store development, renovation, modeling, expansion and acquisitions mainly
from cash generated by our operations.

In
addition, in May 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
capital notes in respect of shareholder loans (NIS 3 million or approximately $0.7 million
of these capital notes were repaid to us during the first quarter of 2007). The capital
notes are unlinked to changes in the CPI and do not bear interest. On April 16, 2007, we
increased to 60% our holdings of Hamachsan Hamerkazi Kfar Hashaashuim Ltd. in
consideration of NIS 5 million or approximately $1.2 million.

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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. As of June 21, 2007, the remaining
principal balance of the NIS 200 million convertible debentures was approximately NIS 77.5
million.

Dividends

The
following table sets forth dividends paid by the Company from January 1, 2005 until the
date of this Annual Report:

|Date of payment    | Amount per share | Total amount*
|------------------ | ---------------- | -------------
|
|
|
|
|April 19, 2007     |                  |              
|                   |                  |              
|September 13, 2006 |                  |              
|                   |                  |              
|June 22, 2006      |                  |              
|                   |                  |              
|April 20, 2006     |                  |              
|                   |                  |              
|September 7, 2005  |                  |              
|                   |                  |              
|January 21, 2005   |                  |              

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

In
addition to the dividends described above, the following dividends were paid by the
Company from 2001 to 2004:

|Year of payment | Amount per share | Total amount*
|--------------- | ---------------- | -------------
|
|
|
|
|2004            |                  |              
|                |                  |              
|2003            |                  |              
|                |                  |              
|2002            |                  |              
|                |                  |              
|2001            |                  |              

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

Blue
Squares board of directors has resolved that we will not distribute dividends in any
quarter if the ratio of our 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 of directors 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%.

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

On
April 12, 2007, BSIP paid a dividend totaling NIS 25 million, or approximately $5.9
million, of which approximately NIS 20 million, or $4.7 million, was distributed to Blue
Square, and approximately NIS 5 million, or $1.2 million, was distributed to other
shareholders.

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.
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
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.

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

On
April 12, 2007, BSRE paid a dividend totaling NIS 9.7 million, or approximately $2.3
million, of which approximately NIS 8 million, or $1.8 million, was distributed to Blue
Square, and approximately NIS 1.7 million, or $0.5 million, was distributed to other
shareholders.

Tabular
Disclosure of Contractual Obligations

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

63

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|                                   | Expected Maturity (NIS in thousands)
|---------------------------------- | ------------------------------------
|
|
|
|
|Long term loans from banks (1)     |                                     
|Non-Convertible                    |                                     
|Debentures issued by the           |                                     
|Company (2)(3)                     |                                     
|Convertible Debentures             |                                     
|issued by the Company (2)(4)       |                                     
|Non-Convertible                    |                                     
|Debentures issued by BSRE (5)(6)   |                                     
|Convertible Debentures             |                                     
|issued by BSRE (5)(7)              |                                     
|                                   |                                     
|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, 2006 (5.8% per annum),
interest payments           on the long-term loans (in thousands) would be NIS 6,730 in
2007, NIS 3,739 in           2008, NIS 1,646 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 (in
thousands) would be NIS 12,017 in 2007, NIS 10,348 in 2008, NIS           8,011 in 2009,
NIS 6,342 in 2010 and, NIS 4,006 in 2011. Without taking into           account any
changes to the Israeli CPI, based on the principal amount of the           Convertible
Debentures as of December 31, 2006 and assuming no additional           conversion of
debentures, interest payments on the Convertible Debentures (in           thousands)
would be NIS 8,152 in 2007, NIS 6,303 in 2008, NIS 4,983 in 2009, NIS           3,135 in
2010 and, NIS 1,829 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, under the terms of           the
debentures, on August 5 of each of the years 2006, 2008 and 2010, the           holders
of the debentures are entitled to early redemption of the principal           provided
that on each of the said dates, we will not repay more than one third           of the
par value of the debentures outstanding as of that date. The table above
          assumes early redemption of these debentures.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | (5) | The
Non-Convertible Debentures and the Convertible Debentures bear interest at           an
annual rate of 4.7% and 6.25%, respectively, and are linked (principal and
          interest) to the Israeli CPI, but in the event the Israeli CPI is less than the
          base index (index known at date of issuance), the amount of debentures will not
          be adjusted below the base index. Without taking into account any changes to
the           Israeli CPI, interest payments on the Non-Convertible Debentures (in
thousands)           would be NIS 30,550 in each of the years 2007 to 2011. Without
taking into           account any changes to the Israeli CPI, based on the principal
amount of the           Convertible Debentures as of December 31, 2006 and assuming no
additional           conversion of debentures, interest payments on the Convertible
Debentures (in           thousands) would be NIS 6,250 in each of the years 2007 to 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.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

64

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

| | (7) | The
principal is repayable in four equal annual installments on August 31 of           each
of the years 2013 to 2016.
| | --- | ----------------------------------------------------------------------------------------------------------------------

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 |            
| |                                       |            
| |                                       |            
| |                                       |            

Long-Term
Loans from Banks

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

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

| | (1) Weighted
average rate as of December 31, 2006.
| | --------------------------------------------------

| | (2) As
of December 31, 2006, includes NIS 96 million at variable interest           (average
annual rate as of December 31, 2006  5.83%, for the major part of           these
loans, based on prime minus 0.32%). The balance of approximately NIS 19           million
is at a fixed annual interest rate of 6.7%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3)           The
balance outstanding at December 31, 2005 includes a loan in the amount of           NIS
500 million which was incurred in connection with the real estate
          reorganization and was repaid in August 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

65

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Debentures

The
following table summarizes outstanding debentures in 2005 and 2006 of the Company and our
80% subsidiary, BSRE:

| |                           | December 31
| | ------------------------- | -----------
|
|
|
|
| | Convertible debentures:   |            
| | Issued by the Company     |            
| | Issued by BSRE            |            
| |                           |            
| |                           |            
| |                           |            
| | Less - current maturities |            
| |                           |            
| |                           |            
| |                           |            
| |                           |            
| | Other debentures:         |            
| | Issued by the Company     |            
| | Issued by BSRE            |            
| |                           |            
| |                           |            
| |                           |            
| | Less - current maturities |            
| |                           |            
| |                           |            
| |                           |            

Blue
Square Debentures

In
August 2003, we issued to institutional investors NIS 400 million in aggregate principal
amount of unsecured 5.9% debentures, half of which (Series B) are currently convertible
into our ordinary shares. All the debentures are linked (principal and interest) to the
Israeli CPI, but in the event the Israeli CPI is less than the base index (index known at
date of issuance), the amount of the debentures will not be adjusted below the base index.
In 2006, convertible debentures (Series B) with a par value of approximately NIS 22.9
million were converted into 742,892 ordinary shares.

Blue
Square Series A Debentures

The
principal of the Series A Debentures is repayable in three equal annual installments on
August 5 of each of the years 2012 to 2014, and the interest is payable semiannually.
Notwithstanding the above, under the terms of the Debentures, on August 5 of each of the
years 2006, 2008 and 2010, the holders of the Series A Debentures are 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.

Blue
Square Series B Debentures

The
principal of the Series B Debentures is repayable in three equal annual installments on
August 5 of each of the years 2007, 2009 and 2011, and the interest is payable
semiannually. The Series B Debentures are convertible into our ordinary shares at a
conversion ratio that is subject to adjustment in the event of distribution of bonus
shares and cash dividends and the issuance of rights. As of December 31, 2006, each NIS
30.079 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, 2006. Subsequent to December 31,
2006, we distributed an additional dividend, which further reduced the conversion ratio
such that each NIS 28.625 par value of debentures is convertible to one Ordinary shares of
1 NIS par value as of May 31, 2007.

66

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

The
terms of the debentures (Series A and Series B) provide that in the event that our
ordinary shares are delisted from trading on the TASE, and/or in the event that our
ordinary shares are no longer held by the public and/or in the event that 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 of directors described under - Dividends above.

BSRE
Debentures

Pursuant
to a prospectus dated August 16, 2006, BRSE made an offering of 2,500,000 BRSE ordinary
shares of NIS 1 par value each, together with NIS 100,000,000 par value of
registered BRSE Series A debentures, which are convertible into BRSE ordinary shares, and
NIS 650,000,000 par value of registered BRSE Series B debentures.

BSRE
Series A Debentures

The
BSRE Series A debentures are to be redeemed in four equal annual installments on August 31
of each of the years 2013 to 2016. The Series A debentures are linked (principal and
interest) to the known Israeli CPI and bear interest at an annual rate of 6.25%, which is
payable semiannually. The Series A debentures are convertible into BSRE ordinary shares
from the date that they are first listed for trade on the stock exchange through August
16, 2016, except during the periods from August 17 through August 31 in each of the years
2013 to 2015. The conversion rate is subject to adjustments in the event of distribution
of cash dividends. Until August 31, 2008, the conversion will be effected at the rate of
NIS 100 par value of registered Series A debentures (NIS 99.12 par value, following
an adjustment on March 27, 2007) for each ordinary share of NIS 1 par value; after
that date and through August 16, 2016, the conversion rate will be NIS 300 par value
of registered Series A debentures (NIS 297.36 par value, following an adjustment on March
27, 2007) for each ordinary share of NIS 1 par value.

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BSRE
Series B Debentures

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

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

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

# Commitments for Capital
Expenditures

As
of December 31, 2006, we had entered into agreements for investments in fixtures,
equipment and leasehold improvements in the total amount of NIS 13.5 million, or $3.2
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. Based on A.C. Nielsen and on data published by
the Israeli Central Bureau of Statistics of the retail sales of food, drinks and tobacco
in Israel, we estimate that approximately 39% of the total retail sales of food, beverages
and tobacco in Israel in 2006 was made by the two large chains and approximately 50% of
the estimated retail sales made by supermarkets, groceries and mini-markets in Israel in
2006 was made by the two large chains  a percentage that is considerably lower than
the estimated market shares prevailing in Europe and the United States.

In
addition, during the last decade, there has been a trend of Israeli consumers purchasing
more in retail chains and less in grocery stores, specialty stores and open-air markets.
According to a household expenditures survey published by the Israeli Central Bureau of
Statistics, in 1997, 44.7% of the Israeli consumer purchases were made at retail chains
and the percentage increased to 53.2% by 2005. This increase in the market share of retail
chains was made at the expense of the market share grocery stores, specialty stores and
open-air markets.

Accordingly,
we believe that there is an opportunity for us to grow correspondingly with the general
growth of the supermarket sector in Israel.

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The
food retailing industry has been subject to increased competition in recent years. As a
result of the 2005 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. Based on A.C. Nielsen, we estimate that Super Sols market share was
approximately 37.7% of the bar-coded market in Israel in 2006, as opposed to our own
approximately 25% share of the bar-coded market in 2006.

In
addition, as a result of consumers focus on the price of products, we and other
major chains have established or expanded low-price and hard discount store formats. Also,
during 2006, very low-priced private supermarkets increased their market share and
expanded their presence in selected areas in Israel, often geographically beyond their
original location. The increased competition has led to increased downward pressure on
prices.

During
the last two years, there was also an increase in sales made by the local neighborhoods
and city centers stores (which have less of a focus on discount prices). Such increase may
suggest that, at least for portion of the consumer market, 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.

In
2006, we opened seven new stores to compete in selective areas in which we did not believe
we had sufficient market presence, and we converted one of our Mega stores into a Shefa
Shuk store. In addition, we plan to continue to remodel some of our supermarkets to give
them a more upscale orientation, offering improved product selection and
increased focus on customer service.

In
2007, we plan to open approximately eight to ten additional supermarkets, totaling
approximately 18,000  25,000 square meters of store space, in localities whose
populations are currently under-served by supermarkets or in localities in which we do not
have sufficient market presence.UntilMay 31, 2007, we opened four
supermarkets stores.

In
2006, we increased our emphasis on increasing our sales, partially in anticipation of an
improving Israeli economy. In 2007, we expect to continue our emphasis on increasing our
sales. This may include increasing our marketing activities.

In
2007, 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.

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In
2007, we are also taking action to increase the variety of Fresh Food items
 such as bakery items, delicatessen, pastry, fresh meat and vegetables offered in
specialty departments. We plan to increase our investments in our Fresh Food
specialty departments and the establishment of these departments in additional stores.

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

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

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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 senior management of
Blue Square and an officer of one of our subsidiaries as of May 31, 2007.

|Name                     | Age | Position                                               
|------------------------ | --- | -------------------------------------------------------
|
|
|
|
|David Wiessman (1)       | 52  | Chairman of the Board of Directors                     
|Yitzhak Bader            | 61  | Director                                               
|Erez Meltzer             | 50  | Director                                               
|Shaul Gliksberg          | 45  | Director                                               
|Shlomo Even (2)          | 50  | Director                                               
|Diana Bogoslavsky        | 48  | Director                                               
|David Alphandary (2) (3) | 72  | Director                                               
|Uzi Baram (1) (2) (3)    | 70  | Director                                               
|Gil Unger*               | 53  | President and Chief Executive Officer                  
|Zeev Stein               | 54  | Chief Executive Officer of Blue Square Real Estate Ltd.
|Dror Moran               | 39  | Vice President and Chief Financial Officer             
|Uri Falach               | 50  | Vice President for Trade                               
|Ilan Buchris             | 55  | Vice President for Planning and Maintenance Division   
|Moshe Shatz              | 59  | Head of Human Resources Division                       
|Oren Lahat               | 59  | Head of Real Estate Development Division               
|Odelia Levanon           | 44  | Head of Information Technology Division                
|Elli Levinson Sela       | 40  | General Counsel and Corporate Secretary                
|Shay Lifshitz            | 53  | Head of Trade Headquarters                             
|Eliezer Gayer            | 50  | "Super Center" Manager                                 
|Uri Kaminsky             | 51  | "Shefa Shuk" Manager                                   
|Rafi Masiach             | 48  | "Mega" Manager                                         
|Dany Magen               | 63  | Head of Supply Chain Division                          

|(1) | Member
of the Compensation Committee.
|--- | -------------------------------------

|(2) | Member
of the Audit Committee.
|--- | ------------------------------

|(3) | External
directors.
|--- | -------------------

* On May 21, 2007, Mr. Unger
announced his intention to resign as Chief Executive Officer and President of the Company.

David
Wiessman has served as Chairman of our board of directors from November 15, 2005 and
as the Vice Chairman of our board of directors from June 2003. Mr. Wiessman is also the
Chairman of the board of directors of BSIP from March 12, 2007 and the Chairman of the
board of directors of BSRE from December 21, 2005. In addition, Mr. Wiessman is currently
the President and Chief Executive Officer of Alon Israel Oil Company Ltd. and President
and Executive Chairman of Dor Alon Energy In Israel (1988) Ltd., Chief Executive Officer
of Bielsol Investments (1987) Ltd., Chairman of the board of directors of Alon Retail,
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. In addition, Mr. Wiessman also serves as a director in other
companies not affiliated with Alon Israel Oil Company Ltd. Mr. Wiessman is a member of
the Compensation Committee of Blue Square.

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

Erez Meltzer has served as our director since August 2006. Mr. Meltzer is currently
Chief Executive Officer of Africa Israel Investments Ltd. Mr. Meltzer serves as a director
in various publicly and closely held (private) companies. Mr. Meltzer served from 2001 to
2006 as President and Chief Executive Officer of Netafim Ltd., and prior to that he served
as the President and Chief Executive Officer of Creo Scitex Ltd. Mr. Meltzer holds a B.A.
degree in Math and Economics from the Hebrew University in Jerusalem and MBA from Boston
University.

Shaul
Gliksberghas served as our director since November 2005. He is currently the Chief
Financial Officer of Africa Israel Investments Ltd. and 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, as well as several other companies. Mr. Gliksberg is a CPA,
holds a B.A. degree in Economics and Accounting from the Bar-Ilan University and an MBA
degree in Business Administration from the Recanati Graduate School of Business
Administration of Tel Aviv University.

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.

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

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

72

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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 as 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 and 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. On May 21, 2007, Mr. Unger announced his intention to resign as
Chief Executive Officer and President of the Company in order to devote his efforts to the
launch of the Alon Groups retail activities in Europe. Mr. Unger will continue in
his present position until Blue Squares new CEO is named.

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

Uri
Falach has served as our Vice President for Trade since December 2003. Mr. Falach
holds an MBA degree in Business Administration from the University of Darby. From 1994
until 2003 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 and 2004 Mr. Buchris served as Authorities Coordinator at Derech
Eretz Highways (1997) Ltd.

73

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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.

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

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

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

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.

74

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Uri
Kaminskyhas served as our Shefa Shuk Manager since April 2007. From April
2004 to April 2007, Mr. Kaminsky served as a Shefa Shuk Operation Manager,
from 2000 to 2004, he served as a Regional Manager in the Company, and from 1995 to 2000,
he served as a store manager.

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. Masiach
holds a degree in Political Science and International Relations from the Israeli Defense
Force College of Command and Headquarters.

Dany
Magen has served as our 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

Yaakov
Shalom Fisher served as our director and as the Chairman of the board of directors of
BSIP until January 2007. Ron Hadassi served as our director until January 2007.
Elisha Eitaniserved as our director until January 2007. Pinchas Cohen
served as our director until August 2006. David Wainshalserved as our external
director and as a member of our Audit Committee until March 2006. Davidi Marom
served as our director until February 2006. Zeev Vurembrandserved as our external
director and as a member of our Audit Committee until January 2006. Yehuda Poratserved as our Shefa Shuk Manager until April 2007.Emanuel Avner
served as our Vice President and Chief Financial Officer until June 2006. Iris Penso,
Adv. served as our General Counsel and Corporate Secretary until February 2006.

# Arrangements for the
Election of Directors

As
of June 21, 2007, Alon Retail owned approximately 70.6% of our ordinary shares following
the conversion by other investors of an aggregate of approximately NIS 122.5 million in
principal amount of our 5.9% convertible debentures since their issuance in August 2003.
So long as Alon Retail continues to own beneficially more than 50% of our outstanding
ordinary shares and voting power, it will be able to control the outcome of matters
requiring shareholder approval, 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.

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| | B. | Compensation.
| | -- | -------------

The
following table sets forth the aggregate compensation we paid or accrued on behalf of all
persons who served as Blue Square directors or senior management for services they
rendered Blue Square, for the year ended December 31, 2006. 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, senior management 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 of directors. The compensation is linked to changes in
Israels CPI since November 2005, and is updated every three months. No additional
fees would be paid to Mr. Wiessman for attending meetings of the board of directors or any
committee of the board of directors. Mr. Wiessman is also entitled to reimbursement of
actual expenses (upon submission of receipts) incurred by him in connection with his
service as Chairman of the board of directors. Our audit committee, board of directors and
shareholders meeting approved this arrangement.

BSIP
paid to 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 directors of BSIP, until his resignation
in January 2007. The compensation was linked to changes in Israels CPI from November
2005, and was updated every three months. No additional fees were paid to Mr. Fisher for
attending meetings of the board of directors or any committee of the board of directors.
Mr. Fisher was 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 of directors.

BSRE
paid to its CEO, Mr. Zeev Stein, from July through December 2006 a total payment which
costs BSRE approximately NIS 595,000. Under his employment agreement, Mr. Stein is
entitled to a salary and customary fringe benefits, including a car lease and social
benefits. In addition, Mr. Stein is entitled to severance compensation in excess of that
which is required under law (200% of required severance in the case of dismissal and 175%
of required severance in case of voluntary termination by Mr. Stein).

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| | 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 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.

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

# Substitute Directors

Our
Articles of Association provide that any director may appoint another person to serve as a
substitute director and may cancel such appointment. The identity of a substitute director
requires the approval of the board of directors. Under the Israeli Companies Law, 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, and if the
substitute director is to replace an external director, (s)he is required to have either
financial and accounting expertise or professional expertise,
depending on the qualifications of the external director (s)he is replacing. Otherwise, a
substitute director cannot be appointed 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.

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# Independent and External
Directors

Israeli
Companies Law Requirements

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

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

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

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

| | control;
and
|- | ------------

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

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

No
person can serve as an external director if the persons position or other business
create, or may create, conflict of interests with the persons responsibilities as an
external director or may impair his ability to serve as a director. Until the lapse of two
years from termination of office, a company may not engage an external director to serve
as an office holder and cannot employ or receive services from that person, either
directly or indirectly, including through a corporation controlled by that person.

Under
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 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.

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

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

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

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

New
York Stock Exchange Requirements

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

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# 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 the company on a regular basis.
|- | ------------------------------------------------------------------------------------

The
role of the audit committee is to examine flaws in the business management of ours, in
consultation with the internal auditor and our independent accountants and suggest
appropriate course of action. In 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.

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.

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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 May 31, 2007, David Alphandary, Uzi Baram and Shlomo Even served as members of Blue
Squares 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.

# Corporate Governance
Practices

A
summary of the significant differences between our corporate governance practices and
those required of U.S. domestic companies under New York Stock Exchange listing standards
is available on Blue Squares website, www.bsi.co.il/en/index.asp (see Blue
Square Corporate Governance Practices under Investor Information).

# Internal Auditor

Under
the Israeli Companies Law, the board of directors must also appoint an internal auditor
proposed by the audit committee. The role of the internal auditor is to examine whether
our actions comply with the law, integrity and orderly business procedure. Under the
Israeli Companies Law, the internal auditor may not be an interested party, an office
holder, or a relative of an interested party, or an office holder, nor may the internal
auditor be our independent accountant or its representative. We comply with this
requirement. Effective January 1, 2005, Ronit Zilberfarb was our internal auditor. On July
31, 2006 Mrs. Zilberfarb has passed away and effective December 28, 2006, Mr. Gershon
Lewinsky serves as our internal auditor.

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

Fiduciary
Duties of Office Holders

The
Israeli Companies Law imposes a duty of care and a duty of loyalty on all office holders
of a company, including directors and executive officers. The duty of care requires an
office holder to act with the level of care, which a reasonable office holder in the same
position would have acted under the same circumstances.

The duty of care includes a duty to
use reasonable means to obtain:

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

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.

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If
the transaction is an extraordinary transaction, both the audit committee and the board of
directors must approve the transaction. Under specific circumstances, shareholders
approval may also be required. A director who has a personal interest in a matter, which
is considered at a meeting of the board of directors or the audit committee, may not be
present at this meeting or vote on this matter. If 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, 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, that
U.S. securities laws and stock exchange rules do not impose the required restriction on
the acquisition of any level of control of a company, and therefore the Israeli Companies
Laws tender offer rules would apply to a company whose shares are publicly traded in
the United States.

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

# Exemption, Insurance and
Indemnification of Directors and Officers

Office
Holder Exemption

Under
the Israeli Companies Law, a company may not exempt an office holder from liability with
respect to a breach of his duty of loyalty, but may exempt in advance an office holder
from his liability to the company, in whole or in part, with respect to a breach of his
duty of care if so provided in its article of association. Blue Squares Articles of
Association so provides. 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.
|- | -----------------------------------------------------------------------------------------------------------

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

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 -Indemnification of Office
Holders above, so long as such indemnification is limited to types of events which,
in the board of directors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 of directors deems reasonable under the circumstances. Such
undertaking must specify the events that in the Board of directors opinion are
foreseeable in view of the Companys actual business at the time of the undertaking
and the amount or the standards that the board of directors deemed reasonable at the
time;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
provision to undertake to indemnify for future events as set forth with respect to
litigation expenses described in clause (ii) under - Indemnification of Office
Holders and in the first paragraph under -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 and officers 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 office holders
service on behalf of our subsidiaries or affiliated companies.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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
breach of the duty of care, which was committed intentionally or recklessly;
|-- | ------------------------------------------------------------------------------

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

|4. | A
fine or monetary composition imposed on him.
|-- | ----------------------------------------------

Pursuant
to resolutions adopted by our shareholders, we obtained and will continue to hold a
directors and officers liability insurance policy. Coverage under our policy
has been set at $30 million (including our subsidiaries, excluding BSRE). We have
purchased directors and officers liability insurance policy for our directors
and officers and those of our subsidiaries, which includes BSIP and its subsidiaries. The
insurance policy is for a period beginning on November 30, 2006, and ending on November
30, 2007, for the maximum coverage of $30 million per claim and in the aggregate during
the policy period. Our audit committee, board of directors and shareholders have approved
any renewal and/or extension of the insurance policy and the purchase of any other
insurance policy, provided that any such renewal, extension or purchase is for the benefit
of Blue Squares previous and/or current and/or future directors and officers and on
terms substantially similar to those of the insurance policy and on condition that the
premium will not increase by more than 25% in any year, as compared to the previous year.
Our current insurance policies comply with these terms.

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.

BSRE
has (i) obtained a separate directors and officers liability insurance policy
with a coverage of $15 million per claim and in the aggregate during the insurance policy
term (beginning on August 10, 2006, and ending on October 31, 2007), (ii) granted letters
of indemnification to BSREs directors and officers in connection with BSREs
initial public offering and in connection with various specified events and (iii) approved
a prospective (in advance) exemption to BSREs directors and officers from liability
for damage resulting from a breach of his duty of care towards BSRE in connection with
actions taken in good faith in their capacity as a director and/or officer of BSRE or in
their capacity as an officer of another company at the request of BSRE.

# 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, 2006, we employed 6,805 employees, counting multiple employees sharing a
single position as a single employee, including 3,536 temporary employees. 705 of our
employees were employed in central management and administration and in our logistics
center and 6,100 in our stores.

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. 660 of our employees were employed in
central management and administration and in our logistics center and 5,930 in our stores.

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

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

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

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

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

In
2006, we have reached an understanding with the employees representative regarding
the increase in the number of employees (quota) who will be deemed to be permanent
employees (tenure) and shortening of the periods required for promotion. A special written
collective bargaining agreement 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 and other conditions of
employment.

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.

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| | E. | Share
Ownership.
| | -- | ----------------

As
of May 31, 2007, other than indirect ownership through Alon Retail, 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 21, 2007, 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)
|---------------------------------------- | -------------------------------------------- | --------------------------------------------
|
|
|
|
|Alon Retail                              |                                              |                                             
|Clal Insurance Enterprises Holdings Ltd. |                                              |                                             

---

|(1) | The
percentage of outstanding ordinary shares is based on 42,419,636 ordinary
               shares outstanding as of June 21, 2007.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

As
of May 31, 2007, Blue Square had approximately 29 shareholders of record with a United
States address. As of May 31, 2007, these United States record holders held approximately
397,946 ordinary shares in the form of ADSs, representing approximately 0.94% of our then
outstanding share capital.

Alon
Retail (formerly Bronfman-Alon) acquired a 78.1% interest in Blue Square from the Co-Op in
June 2003. Alon Retails percentage interest in Blue Square has been reduced to 70.6%
due to the conversion by other investors of an aggregate of approximately NIS 122.5
million in principal amount of our 5.9% convertible debentures since their issuance in
August 2003.

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

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| | 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.

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.

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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.

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

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

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

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

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

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

# Arrangements between
Blue Square and various subsidiaries

Arrangements
among Blue Square, BSIP and Hyper Hyper

On
October 11, 2005, we entered into a general services framework and expenses allotment
agreement with BSIP and Hyper Hyper (the Agreement). The Agreement 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
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.

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

These
provisions in connection with future customer clubs are also applicable to our new joint
Loyalty Plan  YOU with Dor Alon.

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

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

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

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

Leasing
of Property by the Company. The real property that the Company leased to BSIP and/or
to Hyper Hyper has been transferred, and the related lease agreements have been assigned,
to BSRE. See Item 4. Information on the Company  B. Business Overview 
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.

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

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

Employee
Lending Agreement

Hyper
Hyper has entered into an employee lending agreement with Blue Square according to which
Blue Square agreed to make employees available to Hyper Hyper according to Hyper
Hypers needs. Approximately 3,312 employees are working for Hyper Hyper under that
arrangement as of December 31, 2006. 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.

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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 82.2
million in 2006.

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 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. BSRE has confirmed that it is aware of this agreement and that it
will honor this agreement, to the extent relevant to BSRE.

Blue
Center Agreement

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

Inter-Company
Accounts

We,
BSIP and Hyper Hyper agreed to maintain inter-company accounts for day-to-day operations
which 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 6.1% in 2006, 5.2% in 2005 and 5.5% in 2004.

98

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Other
Existing Arrangements

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

Arrangements
between Blue Square and BSRE

In
connection with the transfer of Company real estate assets to BSRE, and in addition to the
agreements between the Company and BSRE described in Item 4. Information on The
Company  B. Business Overview  Real Estate, including the Transfer
Agreement, the Split Agreement and the lease agreements, the Company and BSRE also entered
into the following agreements:

Service
Agreement

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

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

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

99

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Agreement
with respect to the Allocation of Various Insurance Expenses

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

Deposit
of Cash Balances Agreement

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

Ordinary
Course Transactions

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

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. Until January 2007, Mr. Fisher was a director in Alon
Retail (formerly 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 until
January 2007 indirectly held 26.5% of the equity interest of Alon Retail, our controlling
shareholder. Pursuant to the agreement, we paid to Palace approximately NIS 51 million in
2006 for products acquired.

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.

100

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

Not
applicable.

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

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

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

# Board Resolution on
Dividend Distributions

Blue
Squares board of directors has resolved that Blue Square will not distribute
dividends in any quarter if the ratio of Blue Squares 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 of directors 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 of directors resolutions are not the
dividend policy of Blue Square and they may be amended at any time by our board of
directors.

# Legal Proceedings

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.

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

In
2005, the Income Tax Authority issued to the Company tax assessment orders for the years
1999-2001 alleging that certain finance expenses in the amount of approximately NIS 17
million are not to be recognized for tax purposes on the basis that such expenses were
associated with loans incurred for the purpose of distributing a dividend. In 2005, the
Company filed an appeal with the District Court contesting these assessments. In the
opinion of the Company and its advisors, the provisions included in the Company financial
statements are sufficient to cover the potential liabilities. For more information see
Item 3. Key Information  D. Risk Factors  A recent Israeli Supreme Court
decision regarding the deductibility of financial expenses for tax purposes in connection
of dividend distribution could have an adverse effect on our results of operations.

101

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

In
July 2005, the Income Tax Authority issued a notice of a deduction assessment for the
years 2001- 2004 to the Company. The amount claimed under these assessments totaled
NIS 34 million, and primarily relates to certain benefits granted to employees in the
Companys branches. In August 2005, the Company contested these assessments. In
November 2005, several senior employees were questioned under warning, with respect to
these benefits. In August 2006, Income Tax Authority issued to the Company deduction
assessment orders for the years 2001- 2002 in the amount of approximately NIS 22 million.
In September 2006, the Company filed an appeal with the District Court contesting these
assessments. 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.

102

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

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

Other
proceedings

In
2006, we were indicted in connection with discrepancies between the prices appearing on
products, and the prices charged by the cash register at the point of sale. We do not
believe that such indictment will have a material adverse effect on our business. See
Item 4. Information on Blue Square  B. Business Overview  Government
Regulation.

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

# Independent Accountants

On
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. On April 26,
2007, Blue Square shareholders approved the reappointment of Kesselman & Kesselman as
our auditors for the year ending December 31, 2007. 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, 2006.

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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
| | ---- | ---- | ---
|
|
|
|
| | 2002 |      |    
| | 2003 |      |    
| | 2004 |      |    
| | 2005 |      |    
| | 2006 |      |    

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
| | -------------- | ---- | ---
|
|
|
|
| | 2005           |      |    
| | First quarter  |      |    
| | Second quarter |      |    
| | Third quarter  |      |    
| | Fourth quarter |      |    
| |                |      |    
| | 2006           |      |    
| | First quarter  |      |    
| | Second quarter |      |    
| | Third quarter  |      |    
| | Fourth quarter |      |    
| |                |      |    
| | 2007           |      |    
| | 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.

| | 2006     | High | Low
| | -------- | ---- | ---
|
|
|
|
| | December |      |    

| | 2007     | High | Low
| | -------- | ---- | ---
|
|
|
|
| | January  |      |    
| | February |      |    
| | March    |      |    
| | April    |      |    
| | May      |      |    

104

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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 2002, 2003, 2004, 2005 and 2006 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
| | ---- | ---- | ---
|
|
|
|
| | 2002 |      |    
| | 2003 |      |    
| | 2004 |      |    
| | 2005 |      |    
| | 2006 |      |    

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.

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

| | 2006           | High | Low
| | -------------- | ---- | ---
|
|
| | First Quarter  |      |    
| | Second Quarter |      |    
| | Third Quarter  |      |    
| | Fourth Quarter |      |    

| | 2007          | 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.

105

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| | 2006     | High | Low
| | -------- | ---- | ---
|
|
| | December |      |    

| | 2007     | High | Low
| | -------- | ---- | ---
|
|
|
|
| | 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.

|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.

106

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# 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.

# 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.

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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:

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

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

108

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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.

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

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

109

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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. Regulations under the Israeli Companies
          Law exempt companies, like Blue Square, whose shares are listed for trading
both           on a stock exchange in and outside of Israel, from some provisions of the
          Israeli Companies Law. A recent amendment to these regulations is intended to
          also exempt such companies from the requirements of the Israeli proxy
          regulation, under certain circumstances.

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

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

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

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

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

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

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

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

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 The Company  B.
Business Overview  Real Estate, Item 5. Operating and Financial Review and
Prospects  Liquidity and Capital Resources  Debentures, Item 6.
Directors, Senior Management and Employees  C. Board Practices  Exemption,
Insurance and Indemnification of Directors and Officers  Limitations on Insurance
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.

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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.

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.

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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 31% corporate tax rate in 2006 is scheduled to be
reduced to 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.

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:

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| | 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
and thereafter) for individuals (25% if the dividends receipient is a significantshareholder (inter alia, 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 significant
shareholder (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%.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 29% (in 2007) and a marginal tax rate of up to 48% (in 2007) 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 (29%, in 2007, 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).
| | - | ---------------------------------------------------------------------------------

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.

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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 (29% for a corporation in 2007, and a marginal tax rate of
up to 48% 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.

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.

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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.

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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.

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.

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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, unless the invidual has
held the ordinary shares for less than one year, in which event the individual will be
taxed at his marginal tax rate. 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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 2006. 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:

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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.

121

---

---



| | 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 and Debentures in the amount
of approximately NIS 1,133 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 526 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.

The
table below provides information about Blue Squares financial instruments as of
December 31, 2006:

122

---

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|                                                       | December 31, 2006 Expected Maturity (NIS in thousands)
|------------------------------------------------------ | ------------------------------------------------------
|
|
|
|
|Long term loan from banks - linked:                    |                                                       
|                                                       |                                                       
|Linked to the Israeli CPI - 4.68%                      |                                                       
|(weighted average rate as of December 31, 2006)        |                                                       
|                                                       |                                                       
|Long term loans from Bank - unlinked:                  |                                                       
|                                                       |                                                       
|Fixed annual interest rate of 6.7%                     |                                                       
|                                                       |                                                       
|Variable interest (average annual rate as of           |                                                       
|December 31, 2006 - Prime minus 0.32%)                 |                                                       
|                                                       |                                                       
|                                                       |                                                       
|                                                       |                                                       
|                                                       |                                                       
|Debentures - Linked to the Israeli CPI:                |                                                       
|                                                       |                                                       
|Issued by the Company - fixed rate 5.9% (1)            |                                                       
|                                                       |                                                       
|Issued by BSRE - fixed rate 4.7%                       |                                                       
|                                                       |                                                       
|Convertible Debentures Linked to the Israeli CPI:      |                                                       
|Issued by the Company - fixed rate 5.9% (1)            |                                                       
|                                                       |                                                       
|Issued by BSRE - fixed rate 6.25%                      |                                                       
|                                                       |                                                       
|                                                       |                                                       
|                                                       |                                                       
|Deposit in Banks - Variable  interest  (average annual |                                                       
|rate as of December 31, 2006 - Prime minus 1.47%)      |                                                       

(1)
          See also Item 5. Operating and Financial Review and Prospects 
          Liquidity and Capital Resources  Debentures.

For
CPI linked financial instruments as stipulated in the table above, a one
percent increase (decrease) in the CPI would cause an approximately NIS 9.3 million
decrease (increase) in net income for the next year.

Inflation Risks

In
accordance with Israeli Accounting Standard No. 12 adopted by the Israeli Accounting
Standards Boards, 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.

123

---

---



The
table below provides information about the changes of the CPI and the known
CPI index:

| |      | CPI | The "known" CPI index
| | ---- | --- | ---------------------
|
|
|
|
| | 2004 |     |                      
| | 2005 |     |                      
| | 2006 |     |                      

The
table below provides an analysis of monetary assets and liabilities by currency and
linkage as of December 31, 2006:

| |                                                         | Israeli Currency
| | ------------------------------------------------------- | ----------------
|
|
|
|
| | Cash and cash equivalents                               |                 
| | Short-term Investments                                  |                 
| | Trade receivables                                       |                 
| | Short-term deposit                                      |                 
| | Other accounts receivables                              |                 
| | 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 assets (liabilities), net                      |                 
| |                                                         |                 

For
further information regarding market risks, see note 13 to our consolidated financial
statements.

124

---

---



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

| | Not
applicable.
| | ---------------

# PART II

|ITEM 13. |  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
|-------- |  | -----------------------------------------------

| | Not
applicable.
| | ---------------

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

|A. to
E. |  | Not applicable.
|-------- |  | ---------------

|ITEM 15. |  | CONTROLS AND PROCEDURES
|-------- |  | -----------------------

(a) Disclosure Controls and Procedures. We performed an evaluation of the
effectiveness of our disclosure controls and procedures that are designed to ensure that
the material financial and non-financial information required to be disclosed on Form 20-F
and filed with the Securities and Exchange Commission is recorded, processed, summarized
and reported timely within the time period specified in the SECs rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an issuer in the reports
that it files or submits under the Securities 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) Managements Annual Report on Internal Control over Financial Reporting.
Our management, under the supervision of our Chief Executive Officer and Chief Financial
Officer, is responsible for establishing and maintaining adequate internal control over
our financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act
of 1934, as amended. The Companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. Internal control over financial reporting
includes policies and procedures that:

125

---

---



| |  | pertain
to the  maintenance  of  records  that in  reasonable  detail  accurately  and fairly
         reflect our transactions and asset dispositions;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | provide
reasonable assurance that transactions are recorded as necessary to permit the
preparation of our financial statements in accordance with generally accepted accounting
principles;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | provide
reasonable assurance that receipts and expenditures are made only in accordance with
authorizations of our management and board of directors (as appropriate); and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | provide
reasonable assurance regarding the prevention or timely detection of unauthorized
acquisition, use or disposition of assets that could have a material effect on our
financial statements.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Due
to its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. In addition, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.

Under
the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we assessed the effectiveness of our
internal control over financial reporting as of December 31, 2006 based on the
framework for Internal Control-Integrated Framework set forth by The Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment and
this framework, our management concluded that the Companys internal control over
financial reporting were effective as of December 31, 2006.

(c)
          Kesselman & Kesselman, an independent registered public accounting firm in
          Israel and a member of PricewaterhouseCoopers International Limited, which has
          audited the financial statements included in this Annual Report on Form 20-F,
          has issued an attestation report on managements assessment of the
          Companys internal control over financial reporting; their report is
          included in Item 17.

(d)
Changes in Internal Control Over Financial Reporting. There were no
          changes in our internal control over financial reporting that occurred during
          the year ended December 31, 2006 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.

126

---

---



|ITEM 16B. | CODE OF ETHICS
|--------- | --------------

As
of the date of this Annual Report, we have adopted a code of ethics that applies to our
Chief Executive Officer, President, Chief Financial Officer, Corporate Controller and
employees. This code of ethics is posted on our website, www.bsi.co.il/codeofethics. htm.

|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|--------- | --------------------------------------

Kesselman
& Kesselman, a member of PricewaterhouseCoopers International Limited, served as our
independent public accountants for the fiscal years ended December 31, 2005 and 2006, 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 2005 and
2006.

|                       | 2005 | 2006
|---------------------- | ---- | ----
|
|
|
|
|Audit Fees (1)         |      |     
|Audit-Related fees (2) |      |     
|Tax Fees (3)           |      |     
|All Other Fees (4)     |      |     
|                       |      |     
|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; assistance with and review of documents
          filed with the SEC and Sarbanes-Oxley Act compliance.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Audit-related
services in connection with BSREs initial public offering.
| | --- | -------------------------------------------------------------------------

| | (3) | Tax
Fees include fees billed for tax compliance services, including the           preparation
of original and amended tax returns and claims for refund; tax           consultations,
such as assistance and representation in connection with tax           audits and
appeals, tax advice related to mergers and acquisitions,           restructuring,
transfer pricing, and requests for rulings or technical advice           from taxing
authority; tax planning services; and expatriate tax planning and           services.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | 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; and accounting advice services           in connection
with several Company transactions.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

127

---

---



# Audit Committee
Pre-Approval Policies and Procedures

One
of our audit committees main roles is to assist the board of directors in fulfilling
its responsibility for oversight of the quality and integrity of the accounting, auditing
and reporting practices of the Company. The Audit Committee oversees the appointment,
compensation, and oversight of the public accounting firm engaged to prepare or issue an
audit report on the financial statements of the Company. Our audit committee has adopted a
pre-approval policy for audit and non-audit services.

|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
|--------- | -----------------------------------------------------------

Not applicable.

|ITEM 16E. |  | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
|--------- |  | -----------------------------------------------------------------------

None.

128

---

---



# 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  (incorporated by
reference to Exhibit 1.4 to Blue                          Square's Annual Report on Form
20-F for the year ended December 31, 2005).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

129

---

---



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

|4.6 |  | Registration
Rights Agreement,  dated as of July 25,  1996, by and among the Registrant and Co-Op Blue
Square Consumers Cooperative                          Society Ltd. (incorporated by
reference to Exhibit 10.15 to the Registration Statement on Form F-1 (File No.
333-05024)).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Letter,
 dated July 1,  1996, by Co-Op Blue Square Consumers  Cooperative Society Ltd.
 indemnifying the Registrant against certain                          real estate tax
 liabilities  (incorporated  by  reference  to Exhibit  10.17 to the  Registration
 Statement on Form F-1 (File No.                          333-05024)).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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, 2004).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Special
 Collective  Bargaining  Agreement  made on April 26, 2006 among Blue Square,  the MAOF
 Histadrut  and Blue  Square-Israel                          Employees' Union (English
translation).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | Special
 Collective  Bargaining  Agreement  made on May 29,  2006 among Blue  Square,  the MAOF
 Histadrut  and Blue  Square-Israel                          Employees' Union (English
translation).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

130

---

---



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

|4.18 |  | Deed
of Trust made on August 5, 2003,  by and between  Blue Square - Israel  Ltd.  and Israel
 Discount  Bank Trust  Company  Ltd.,                          together with second
schedule  (English  translation)  (incorporated by reference to Exhibit 4.18 to Blue
Square's Annual Report on                          Form 20-F for the year ended December
31, 2003).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

|4.22 |  | General
 services  framework  and  expenses  allotment  agreement,  dated  October 11, 2005,
 among Blue Square,  Blue Square Chain                          Investments & Properties
 Ltd. and Blue Square Chain (Hyper Hyper) Ltd., as amended  (incorporated  by reference
to Exhibit 4.21 to                          Blue Square's Annual Report on Form 20-F for
the year ended December 31, 2005).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.23 |  | Transfer
Agreement, dated June 21, 2006, between Blue Square and Blue Square Real Estate Ltd.
(English translation)
|---- |  | -------------------------------------------------------------------------------------------------------------------

|4.24 |  | Split
Agreement, dated April 2, 2006, between Blue Square and Blue Square Real Estate Ltd.
(English translation)
|---- |  | ----------------------------------------------------------------------------------------------------------------

|4.25 |  | Lease
Agreement, dated August 13, 2006, between Blue Square and Blue Square Real Estate Ltd.
(English translation)
|---- |  | ------------------------------------------------------------------------------------------------------------------

|4.26 |  | Lease
 Agreement,  dated June 23, 2006,  between Blue Square and Blue Square Chain  Investments
 & Properties  Ltd Blue Square Real                          Estate Ltd (assigned to
BSRE) (English translation)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.27 |  | Service
Agreement, dated August 13, 2006, between Blue Square and Blue Square Real Estate Ltd.
(English translation)
|---- |  | --------------------------------------------------------------------------------------------------------------------

|4.28 |  | Underwriting
 Agreement,  dated August 15, 2006, among Blue Square Real Estate Ltd., and Poalim I.B.I
Underwriting and Issues Ltd.,                          Africa-Israel Issues Ltd.,
Discount Underwriting and Issues Ltd. and various other underwriters (English
translation).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.29 |  | Deed
of Trust (for Series A  Debenture)  made on August 14, 2006,  by and between  Blue Square
Real Estate Ltd. and Hermetic  Trust                          (1975) Ltd., together with
second schedule (English translation).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.30 |  | First
 Schedule to Deed of Trust -  Debenture  Certificate  for  Registered  Debentures
 (Series A) of NIS 1 par value each (out of                          series of NIS
100,000,000 par value Debentures (Series A)) (English translation).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.31 |  | Deed
of Trust (for Series B  Debenture)  made on August 14, 2006,  by and between  Blue Square
Real Estate Ltd. and Hermetic  Trust                          (1975) Ltd., together with
second schedule (English translation).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

131

---

---



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

|4.32 |  | First
 Schedule to Deed of Trust -  Debenture  Certificate  for  Registered  Debentures
 (Series B) of NIS 1 par value each (out of                          series of NIS
650,000,000 par value Debentures (Series B)) (English translation).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

132

---

---



# BLUE SQUARE 
ISRAEL LTD.

# 2006 ANNUAL REPORT

TABLE OF CONTENTS

|                                                                             | Page       
|---------------------------------------------------------------------------- | -----------
|
|
|
|
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                      | 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-67
|                                                                            
|APPENDIX I - DETAILS OF PRINCIPAL SUBSIDIARIES, PROPORTIONATELY CONSOLIDATED
|COMPANIES AND AN ASSOCIATED COMPANY                                          | F-68       
|                                                                            
|APPENDIX II  - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM      
|for subsidiary of the Company, Hamachsan Hamerkazi Kfar Hashaasuim Ltd.      | F-69       
|                                                                            
|APPENDIX III  - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     
|for subsidiary of the Company, Radio Non-Stop Ltd.                           | F-70       



---

---



|
|
|

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

# BLUE SQUARE 
ISRAEL LTD

We have completed an integrated audit
of the 2006 consolidated financial statements of Blue Square  Israel Ltd. and its
subsidiaries and proportionately consolidated companies (collectively  the
Company) and of its internal control over financial reporting as of
December 31, 2006 and audits of its 2005 and 2004 consolidated financial statements
in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

We have audited the consolidated
balance sheets of Blue Square  Israel Ltd. and its subsidiaries and proportionately
consolidated companies as of December 31, 2006 and 2005 and the related consolidated
statements of operations, changes in shareholders equity and cash flows for each of
the three years in the period ended December 31, 2006. 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 4.2% and 3.64% of total consolidated assets as of December 31, 2006 and
2005, respectively, and whose revenues included in consolidation constitute approximately
3.5% and 1.57% of total consolidated revenues for the years ended December 31, 2006 and
2005 , respectively. We also did not audit the financial statements of associated company,
the Companys interest in which as reflected in the balance sheets as of December 31,
2006 is NIS 4.8 million, and the Companys share in profit is  NIS 1.3 million
for the year ended December 31, 2006. The
financial statements of the above subsidiary and associated company were audited by other
independent registered public accounting firm, whose reports have been furnished to us,
and our opinion, insofar as it relates to amounts included for those companies, is based
on the report of other independent registered public accounting firm.

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

In our opinion, based on our audits
and the report of the other independent registered public accounting firm, the
consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of the Company and its subsidiaries and
proportionally consolidated companies as of December 31, 2006 and 2005 and the
consolidated results of operations, and cash flows for each of the three years in the
period ended December 31, 2006, 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.  Information relating to the nature and
effect of such differences is presented in note 18 to the consolidated financial
statements.

F - 2

---

---



As explained in note 2a, the
financial statements referred to above are presented in New Israeli Shekels, in conformity
with accounting standards issued by the Israel Accounting Standards Board.

Without qualifying our opinion, we
draw attention to the fact that on January 1, 2006, a number of new accounting standards
of the Israel Accounting Standards Board became effective and were implemented by the
Company in the preparation of these financial statements; as detailed in note 2t, the
standards were applied retroactively and comparative figures were restated in these
financial statements regarding the computation of earnings per share, as prescribed by the
relevant standard.

# Internal control over
financial reporting

Also, in our opinion,
managements assessment, included in Report of the Companys Management on
Internal Control Over Financial Reporting appearing under item 15, that the Company
maintained effective internal control over financial reporting as of December 31,
2006 based on criteria established in Internal Control  Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria. Furthermore, in our opinion,
the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2006, based on criteria established in
Internal Control  Integrated Framework issued by the COSO. The Companys
management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express opinions on managements assessment and
on the effectiveness of the Companys internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial reporting in
accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained
in all material respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit provides a reasonable basis for
our opinions.

A companys internal control
over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the
company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets
that could have a material effect on the financial statements.

Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

|Tel-Aviv, Israel 
    June 28, 2007 | Kesselman & Kesselman
Certified Public Accountants (Israel)
|----------------------------------- | -----------------------------------------------------------

F - 3

---

---



# BLUE SQUARE 
ISRAEL LTD.

CONSOLIDATED BALANCE
SHEETS

|                                                                 |  |  |     | Convenience
translation
(note 2p)
|---------------------------------------------------------------- |  |  | --- | ---------------------------------
|
|
|
|
|
|A s s e t s                                                      |  |  | 11  |                                  
|                                                                 |  | 
|CURRENT ASSETS:                                                  |  |  | 14  |                                  
|Cash and cash equivalents                                        |  |  | 2c  |                                  
|Marketable securities                                            |  |  | 15a |                                  
|Deposit in bank                                                  |  |  |     |                                  
|Trade receivables                                                |  |  | 15b |                                  
|Other accounts receivable                                        |  |  | 15c |                                  
|Inventories                                                      |  |  | 15d |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|Total current assets                                             |  |  |     |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|INVESTMENTS AND LONG TERM RECEIVABLES:                           |  | 
|Restricted deposit                                               |  |  |     |                                  
|Investments in associated companies                              |  |  | 3   |                                  
|Other long-term receivables                                      |  |  | 15e |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|FIXED ASSETS, NET OF ACCUMULATED DEPRECIATION
  AND AMORTIZATION |  |  | 4   |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|DEFERRED TAXES                                                   |  |  | 12b |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION:                   |  |  | 5   |                                  
|Goodwill                                                         |  |  |     |                                  
|Deferred charges                                                 |  |  |     |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|                                                                 |  |  |     |                                  
|                                                                 |  |  |     |                                  
|                                                                 |  | 
|                                                                 |  |  |     |                                  
|                                                                 |  |  |     |                                  

|June 28, 2007
Date of approval of thefinancial statements | 
David WiessmanChairman of the Board
of Directors | 
Gil UngerChief Executive Officer | 
Dror MoranVice President and
Chief Financial Officer
|--------------------------------------------------------------------- | ------------------------------------------------------------- | --------------------------------------------- | -----------------------------------------------------------------

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

F - 4

---

---



# BLUE SQUARE 
ISRAEL LTD.

CONSOLIDATED BALANCE
SHEETS

|                                             |  |  |        | Convenience
translation
(note 2p)
|-------------------------------------------- |  |  | ------ | ---------------------------------
|
|
|
|
|
|Liabilities and shareholders' equity         |  |  |        |                                  
|                                             |  | 
|CURRENT LIABILITIES:                         |  |  | 11, 14 |                                  
|Credit and loans from banks                  |  |  | 15f    |                                  
|Current maturities of debentures             |  |  | 7      |                                  
|Trade payables                               |  |  |        |                                  
|Other accounts payable and accrued expenses  |  |  | 15g    |                                  
|                                             |  |  |        |                                  
|                                             |  | 
|Total current liabilities                    |  |  |        |                                  
|                                             |  |  |        |                                  
|                                             |  | 
|LONG-TERM LIABILITIES:                       |  | 
|Long-term loans from banks, net of current   |  | 
|maturities                                   |  |  | 6      |                                  
|Debentures, net of current maturities        |  |  | 7      |                                  
|Convertible debentures, net of current       |  | 
|maturities                                   |  |  | 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                            |  |  | 15h    |                                  
|                                             |  |  |        |                                  
|                                             |  | 
|SHAREHOLDERS' EQUITY:                        |  |  | 10     |                                  
|Share capital -                              |  | 
|Ordinary shares of NIS 1 par value -         |  | 
|Authorized: 100,000,000 shares as of         |  | 
|December 31, 2006 and 2005; Issued and       |  | 
|outstanding 39,692,983 and 38,950,091        |  | 
|shares as of December 31, 2006 and 2005,     |  | 
|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

|                                         |  | 2004 | 2005 | 2006 | Convenience
translation
(note 2p)
2006
|---------------------------------------- |  | ---- | ---- | ---- | --------------------------------------
|
|
|
|
|
|
|Sales                                    |  |      | 2m   |      |                                       
|Cost of sales                            |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Gross profit                             |  |      |      |      |                                       
|Selling, general and administrative      |  |     
|expenses                                 |  |      | 15i  |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Operating income                         |  |      |      |      |                                       
|Financial expenses, net                  |  |      | 15j  |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|                                         |  |      |      |      |                                       
|                                         |  |     
|Amortization of goodwill                 |  |      |      |      |                                       
|Other income (expenses), net             |  |      | 15k  |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Income before taxes on income            |  |      |      |      |                                       
|Taxes on income                          |  |      | 12d  |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Income after taxes on income             |  |      |      |      |                                       
|Share in profits (losses) of associated  |  |     
|companies, net                           |  |      |      |      |                                       
|Minority interest in profits of          |  |     
|subsidiaries, net                        |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Net income for the year                  |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Net income per Ordinary share or ADS:    |  |      | 2t   |      |                                       
|                                         |  |     
|Basic                                    |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Fully diluted                            |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Weighted average number of shares or ADS |  |     
|used for computation of income per       |  |     
|share:                                   |  |     
|                                         |  |     
|Basic                                    |  |      |      |      |                                       
|                                         |  |      |      |      |                                       
|                                         |  |     
|Fully diluted                            |  |      |      |      |                                       
|                                         |  |      |      |      |                                       

* after retrospective application of
accounting change  see note 2t.

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, 2004              |  |  |                   | 52,121
|                                        |  | 
|CHANGES DURING 2004:                    |  | 
|                                        |  | 
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                   | 382   
|Dividend paid                           |  |  |                   | -     
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                   | -     
|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 10c)              |  |  |                   | -     
|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
|                                        |  | 
|CHANGES DURING 2006:                    |  | 
|                                        |  | 
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                   | 743   
|Dividend paid                           |  |  |                   | -     
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                   | -     
|Net income                              |  |  |                   | -     
|                                        |  |  |                   |       
|                                        |  | 
|BALANCE AT DECEMBER 31, 2006            |  |  |                   | 53,414
|                                        |  |  |                   |       
|                                        |  | 
|
|                                        |  | 
|BALANCE AT JANUARY 1, 2006              |  |  |                   | 12,466
|                                        |  | 
|CHANGES DURING 2006:                    |  | 
|                                        |  | 
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                   | 176   
|Dividend paid                           |  |  |                   | -     
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                   | -     
|Net income                              |  |  |                   | -     
|                                        |  |  |                   |       
|                                        |  | 
|BALANCE AT DECEMBER 31, 2006            |  |  |                   | 12,642
|                                        |  |  |                   |       

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

|                                                      |  |  |  | Convenience
translation
(note 2p)
|----------------------------------------------------- |  |  |  | ---------------------------------
|
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                 |  |  |  |                                  
|                                                      |  | 
|Net income                                            |  |  |  | 60,548                           
|Adjustments required to reflect the cash flows        |  | 
|from  operating activities (a)                        |  |  |  | 288,010                          
|                                                      |  |  |  |                                  
|                                                      |  | 
|Net cash provided by operating activities             |  |  |  | 348,558                          
|                                                      |  |  |  |                                  
|                                                      |  | 
|CASH FLOWS FROM INVESTING ACTIVITIES:                 |  | 
|                                                      |  | 
|Purchase of fixed assets                              |  |  |  | (89,404                          
|Investment in restricted deposit and long-term        |  | 
|receivables                                           |  |  |  |                                  
|Collection of other long-term receivalbes             |  |  |  | -                                
|Grant of long-term loan                               |  |  |  | -                                
|Proceeds from sale of fixed assets                    |  |  |  | 11,527                           
|Deconsolidation of former investee company (c)        |  |  |  | (505                             
|Realization (purchase) of marketable securities, net  |  |  |  | 15,817                           
|Proceeds from realization of investment in a          |  | 
|subsidiary                                            |  |  |  | -                                
|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)                                        |  |  |  | -                                
|Long term loan to a former investee company, net      |  |  |  | (5,997                           
|                                                      |  |  |  |                                  
|                                                      |  | 
|Net cash used in investing activities                 |  |  |  | (68,562                          
|                                                      |  |  |  |                                  
|                                                      |  | 
|CASH FLOWS FROM FINANCING ACTIVITIES:                 |  | 
|                                                      |  | 
|Issuance of shares to minority shareholders in        |  | 
|consolidated subsidiary, net of issuance expenses     |  |  |  | -                                
|Issuance of debentures and convertible debentures,    |  | 
|net of issuance expenses                              |  |  |  | -                                
|Dividends paid to shareholders                        |  |  |  | (252,811                         
|Dividend paid to minority shareholders of             |  | 
|subsidiaries                                          |  |  |  | (77,040                          
|Receipt of long-term loans                            |  |  |  | 426,762                          
|Repayments of long-term loans                         |  |  |  | (357,609                         
|Repayment of capital note to previous shareholders    |  | 
|of subsidiary, net                                    |  |  |  | -                                
|Short-term loans from minority in subsidiaries        |  |  |  | -                                
|Short-term credit from banks, net                     |  |  |  | (35,194                          
|                                                      |  |  |  |                                  
|                                                      |  | 
|Net cash provided by (used in) financing activities   |  |  |  | (295,892                         
|                                                      |  |  |  |                                  
|                                                      |  | 
|INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS      |  |  |  | (15,896                          
|BALANCE OF CASH AND CASH EQUIVALENTS AT               |  | 
|BEGINNING OF YEAR                                     |  |  |  | 63,255                           
|                                                      |  |  |  |                                  
|                                                      |  | 
|BALANCE OF CASH AND CASH EQUIVALENTS AT END OF   YEAR |  |  |  | 47,359                           
|                                                      |  |  |  |                                  
|                                                      |  | 
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES:      |  | 
|                                                      |  | 
|Cash paid during the year for interest                |  |  |  | 52,501                           
|                                                      |  |  |  |                                  
|                                                      |  | 
|Cash paid during the year for taxes                   |  |  |  | 39,038                           
|                                                      |  |  |  |                                  

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

|                                                                                   | 2004 | 2005 | 2006 | Convenience
translation
(note 2p)
2006
|---------------------------------------------------------------------------------- | ---- | ---- | ---- | --------------------------------------
|
|
|
|
|(a) Adjustments required to reflect the cash flows from      operating activities: |      |      |      |                                       
|                                                                                   |      |     
|Income and expenses not involving cash flows:                                      |      |     
|Depreciation and amortization                                                      |      |      |      | 146,201                               
|Minority interest in profits of subsidiaries - net                                 |      |      |      | 13,555                                
|Share in losses (profits) of an associated companies                               |      |      |      | 1,204                                 
|Capital gain from realization of investments (see                                  |      |     
|notes 3(c)(d)(e))                                                                  |      |      |      | -                                     
|Loss (gain) from sale, disposal and impairment of                                  |      |     
|fixed assets                                                                       |      |      |      | 5,994                                 
|Deferred income taxes, net                                                         |      |      |      | 9,526                                 
|Linkage differences on long-term loans and other                                   |      |     
|liabilities, net                                                                   |      |      |      | 5,195                                 
|Repayments of interest regarding long-term loan                                    |      |      |      | -                                     
|Increase in liability for employee rights, net                                     |      |      |      | 1,476                                 
|Increase in value of marketable securities, deposit                                |      |     
|and long term receivables, net                                                     |      |      |      | (680                                  
|Changes in operating assets and liabilities:                                       |      |     
|Decrease (increase) in trade receivables and other                                 |      |     
|accounts receivable                                                                |      |      |      | 4,134                                 
|Increase in inventories                                                            |      |      |      | (13,389                               
|Increase (decrease) in trade payables and other                                    |      |     
|accounts payable                                                                   |      |      |      | 114,794                               
|                                                                                   |      |      |      |                                       
|                                                                                   |      |     
|                                                                                   |      |      |      | 288,010                               
|                                                                                   |      |      |      |                                       
|                                                                                   |      |     
|(b) Acquisition of subsidiaries 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 taxes, net                                                                |      |      |      | -                                     
|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                             |      |      |      | -                                     
|Investments in affiliates                                                          |      |      |      | -                                     
|                                                                                   |      |      |      |                                       
|                                                                                   |      |      |      | -                                     
|                                                                                   |      |      |      |                                       
|                                                                                   |      |     
|(c) Deconsolidation of former investee company                                     |      |     
|                                                                                   |      |     
|Assets and liabilities of this company at date of                                  |      |     
|deconsolidation:                                                                   |      |     
|Working capital deficiency (excluding cash and cash                                |      |     
|equivalents)                                                                       |      |      |      | (5,833                                
|Fixed assets and investments                                                       |      |      |      | 6,658                                 
|Long term liabilities                                                              |      |      |      | (6,941                                
|Carrying amount of the investment at the date of the                               |      |     
|deconsolidation                                                                    |      |      |      | 5,611                                 
|                                                                                   |      |      |      |                                       
|                                                                                   |      |      |      | (505                                  
|                                                                                   |      |      |      |                                       
|                                                                                   |      |     
|(d) Supplementary information on investing and financing                           |      |     
|activities not involving cash flows:                                               |      |     
|                                                                                   |      |     
|Purchasing fixed assets on credit                                                  |      |      |      | -                                     
|                                                                                   |      |      |      |                                       
|Issuance of shares upon conversion of convertible                                  |      |     
|debentures                                                                         |      |      |      | 13,638                                
|                                                                                   |      |      |      |                                       
|Dividend payable                                                                   |      |      |      | 39,405                                
|                                                                                   |      |      |      |                                       
|Sale of fixed assets on credit                                                     |      |      |      | -                                     
|                                                                                   |      |      |      |                                       
|Dividend to pay to minority in a subsidiary                                        |      |      |      | -                                     
|                                                                                   |      |      |      |                                       

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

| | As
of December 31, 2006, Bronfman-Alon Ltd. holds approximately 75.45% of the share capital
of the company.
| | -----------------------------------------------------------------------------------------------------------

| | c. | In
June 2006, the Company completed the transfer (effective as of December 31,
               2005) of its directly owned real estate assets (excluding real estate
owned by                its subsidiary, Blue Square Chain Investments & properties
Ltd.                Hereafter-BSIP) and certain liabilities to a new wholly-owned
subsidiary that                was established for this purpose. See also note 3d.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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

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---



# 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, as it
related to the Company, is presented in note 18.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to adoption of International Financial Reporting Standards (IFRS), which is to be carried
out in reporting periods commencing on January 1, 2008 and thereafter, see x. below.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
significant accounting policies which, except for the changes in the accounting policies
that relate to the recognition and classification of financial instruments, to the
recognition of revenue, to the recognition and treatment of goodwill and intangible
assets originating from the acquisition of an investee company, the amortization of
debentures issuance costs, and after taking into account, by means of retrospective
application, the accounting change with regard to the computation of earnings per share,
which result from the application, in 2006, of new accounting standards of the Israel
Accounting Standards Boards (hereafter  the IASB), were applied on a consistent
basis, are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | The
Company presents its financial statements in NIS, in accordance with the provisions of
Israel Accounting Standard No. 12  Discontinuance of Adjusting Financial
Statements for Inflation  of the IASB, which establishes principles for
transition to nominal reporting, commencing January 1, 2004 (hereafter - the
transition date).Accordingly, amounts that relate to non-monetary assets
(including depreciation and amortization thereon), investments in associated companies
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 at their nominal values.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | 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. The companies included in consolidation are listed in the
          appendix 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 Institute of Certified Public Accountants in Israel. As
          to data relating to such companies included in these consolidated financial
          statements  see also note 3c.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | In
accordance with the provisions of Standard No. 20 (As Amended) of the
          IASB, which is applied by the company since January 1, 2006, from that
          date, amortization of goodwill was discontinued, and goodwill and certain
          intangible assets must be tested for impairment at least once a year, (see j.
          below).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amounts of amortization of goodwill, for the years ended December 31, 2005 and 2004
are NIS 6,508 thousand and NIS 5,870 thousand respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 in Israel and the trade
receivables consist mainly of receivables from credit card companies and cash.
Accordingly, the Companys trade balances do not represent a substantial
concentration of credit risks at December 31, 2006. 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
mainly 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the changes in the accounting treatment of inventory, commencing January 1, 2007,
following the application of Israeli Accounting standard No. 26 of the IASB, inventory  see
x. below.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | g. | Investment
in an associated companies
| | -- | -------------------------------------

| | 1) | Investment
in associated companies 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 investments, in the associated companies.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | As
to the changes in the accounting treatment of property, plant and equipment, commencing
January 1, 2007, resulting from the application of Israel Accounting Standard No. 27
of the IASB, Property, Plant and Equipment  see x. below.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the changes in the accounting treatment of investment property, commencing January 1,
2007, resulting from the application of Israel Accounting Standard No. 16 of the
IASB, Investment Property - see x. below.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Other
assets and 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 were amortized over the period of                the
debentures, using the straight line method, in proportion to their
               outstanding balance.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the changes in accounting policy effective January 1, 2006, relating to the method of
presenting and amortizing these charges  see note k. below.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 14

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

| | 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, 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 partly or fully reversed in the period, 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, see note 4b.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to Israel Accounting Standard No. 20 (as amended) of the IASB, which is applied by the
company since January 1, 2006, goodwill and certain intangible assets must be tested
for impairment at least once a year - see i. above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

| | Effective
January 1, 2006, the Company prospectively adopted Israeli Accounting Standard No. 22 of
the IASB, pursuant to which, the liability component and the equity component imputed in
the convertible debentures should be recognized separately in the balance sheet. The fair
value of the liability component is determined based on the customary interest rate
applicable to debentures with similar features that do not include a conversion option.
The remaining balance of the proceeds should be attributed to the conversion option
incorporated in the debentures, and presented under shareholders equity. According
to this standard transaction costs should be proportionately allocated to the components
of the debentures. The portion of the transaction costs attributed to the liability
component should be deducted from the liability and taken into account in computing the
effective interest rate, and the portion of transaction costs attributed to the equity
component should be deducted from shareholders equity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has examined the fair value of the liability component and the equity component
imputed in the convertible debentures. Since the equity component is immaterial, it has
not been seperated.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
accounting treatment applied through December 31, 2005 in connection with the
classification of debentures convertible into shares was as follows: The debentures,
which as of December 31, 2005 and 2004 were not expected to be converted, were presented
at the amount of the liability at the balance sheet date and are presented among
long-term liabilities. As to changes in the accounting treatment of transaction costs in
respect of issuance of debentures, see w. below.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 1) | Effective
January 1, 2005, the Company applied 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 - 16

---

---



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

| | 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
| | -- | -------------------

| | Commencing
January 1, 2006, the Company applies Israel Accounting Standard No. 25 of the
IASB  Revenue, which 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).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
is measured, as detailed below, at the fair value of the consideration received or the
consideration that the Company is entitled to receive, taking into account trade
discounts and/or bulk discounts granted by the entity:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | Revenue
from sale of goods is 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Upon
the application of the standard, the Company separates the financing component embedded
in revenue from sales made on credit for periods exceeding the customary credit period in
its industry (approximately 90 days), that does not bear interest at the appropriate
rate. Revenue from the financing component is recognized over the credit period. Through
December 31, 2005, the Company did not separate the financing component in respect
of sales made on credit, as above, and included within revenue from the sale on the date
of recognition of such revenue.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
effect of the application of the standard on the accumulated effect as of January 1, 2006
and for the year 2006 is immaterial.
| | ----------------------------------------------------------------------------------------------------------------------------------

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

| | Club
members participating in the Companys programs are entitled to earn benefits upon
purchasing goods, which can be utilized over a specific term to receive certain free
gifts or discounts on products or receive certain products sold by the Company free of
charge. The value of such benefits, adjusted for benefits 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 benefits 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

| | The
financial statements as of December 31, 2006 and for the year then ended have been
translated into U.S. dollars at the representative rate of exchange on December 31, 2006
(U.S. $ 1 = NIS 4.225). 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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
per share (EPS)
| | -- | --------------------------

| | Commencing
January 1, 2006, the Company applies the provisions of Israel Accounting Standard No. 21
of the IASB, Earnings per Share. The computation of basic net income per
share is generally based on earnings available for distribution to holders of ordinary
shares, divided by the weighted average number of ordinary shares outstanding during the
period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
computing diluted net income per share, the weighted average number of shares to be
issued, assuming that all dilutive potential shares are converted into shares, is to be
added to the average number of ordinary shares used in the computation of the basic
income per share. Potential shares are taken into account, as above, only when their
effect is dilutive (reducing net income or increasing loss per share from continuing
activities).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | Comparative
net income per share figures included in these financial statements reflect a
retrospective application of the new standards computation directives.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. From time to time 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | w. | Financial
instruments
| | -- | ---------------------

| | Commencing
January 1, 2006, the Company applies Israel Accounting Standard No. 22 of the IASB
 Financial Instruments: Disclosure and Presentation (hereafter -
Standard 22), which prescribes the rules for presentation of financial instruments and
the proper disclosure required therefore, as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1) | Issuance
of multiple classes of securities in a single transaction
| | -- | ------------------------------------------------------------------

| | The
proceeds received from the issuance of a package of securities of a subsidiary were
allocated to the various components based on market prices of the securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Offset
of financial instruments
| | -- | -------------------------------

| | Financial
assets and financial liabilities are presented on the balance sheet at their net amount,
only when the Company has a legally enforceable right to effect such set off, and subject
to the existence of an intent to settle the asset and the liability on a net basis, or to
realize the asset and settle the liability simultaneously.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

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---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | 3) | As
to the accounting treatment of debentures convertible into shares, see k.
          above.
| | -- | ---------------------------------------------------------------------------------------------

| | 4) | In
accordance with the transitional provisions of Israeli Accounting Standard           No.
22, commencing January 1, 2006, in addition to the aforesaid, the
          financial statements include the following changes:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of deferred issuance costs, which at December 31, 2005 amounted to NIS 1,627
thousands, has been reclassified and presented as a deduction from the amount of the
liabilities to which such expenses relate. As from January 1, 2006, these expenses
are deducted from the liability and are included in the computation of the effective
interest rate (see k. above). Through December 31, 2005, deferred issuance costs
were included under other assets and amortized according to the straight-line method.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | x. | Recently
issued accounting pronouncements in Israel
| | -- | ---------------------------------------------------

| | 1. | Israeli
Accounting Standard No. 29 of the IASB  Adoption of International
Reporting Financial Standards (IFRS)"
| | -- | -----------------------------------------------------------------------------------------------------------------

| | This
standard, which was issued in July 2006 by the IASB provides that companies, which are
subject to the Securities Law, 1968 and are required to report  pursuant to
regulations issued thereunder  in accordance with said law, shall draw up their
financial statements under International Financial Reporting Standards (IFRS) with effect
from reporting periods commencing on January 1, 2008 (viz. effective from the first
quarter of 2008). Pursuant to the provisions of the Standard, such companies and other
companies may elect early adoption of the Standard, and prepare their financial
statements under IFRS, commencing with the financial statements that are published
subsequent to July 31, 2006.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard prescribes that companies, which do not draw up their financial statements under
IFRS and are required or elect, as stated above, to prepare their financial statements
for the first time under IFRS, shall apply the provisions specified in International
Financial Reporting Standard No. 1 (IFRS 1)- First-Time Adoption of
International Financial Reporting Standards in making the transition. IFRS 1, which
deals with the first-time transition to reporting under IFRS, provides that, in the first
annual financial statements that are drawn up under IFRS (including the interim financial
statements for that year), all the latest IFRS standards in effect at the end of the
reporting year in which the Company reports under IFRS, shall be applied retroactively
(with the exception of certain reliefs and prohibitions, as referred to below). IFRS 1
specifies two groups of exceptions to the principle of retroactive implementation: (1) reliefs
concerning mandatory retroactive implementation with regard to certain defined topics,
while providing the option that the reliefs be utilized in full or in part, and (2)
prohibitions concerning mandatory retroactive implementation with regard to defined
topics. Pursuant to the provisions of IFRS 1, the first financial statements drawn
up under IFRS shall include at least one years comparative data. Accordingly, a
company that draws up its financial statements under IFRS for the first time for periods
commencing after January 1, 2008 and that elects to present comparative data for one year
only shall be required, pursuant to IFRS 1, to prepare an opening balance sheet as
of January 1, 2007, which shall be drawn up under IFRS. In preparing this opening balance
sheet, all the latest IFRS standards, as referred to above, with regard to the
recognition, non-recognition, classification and measurement of all its revenues,
liabilities and shareholders Equity items, shall be applied by the aforesaid
company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

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---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | IFRS 1
also establishes certain disclosure requirements that apply to the financial statements
that are drawn up for the first time under IFRS. Pursuant to these disclosure
requirements, companies applying IFRS for the first time are required to explain what
effect the transition from the previously generally accepted accounting principles (GAAP)
to IFRS has had on their reported financial position, operating results and cash flows.
In addition, such companies are required to include notes providing reconciliations of
the data reported under the previous GAAP, to the data reported under IFRS, in respect of
their shareholders equity and income statements as of certain dates and for certain
periods.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, Israel Accounting Standard No. 29 requires companies, which draw up their
financial statements under IFRS for the first time, for periods commencing after January
1, 2008, to disclose, in a note in their financial statements for 2007, balance sheet
data as of December 31, 2007 and income statement data for the year ended December 31,
2007, as they would appear after applying IFRS recognition, measurement and presentation
rules.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | IFRS
differ from Israeli GAAP and, accordingly, financial statements drawn up under IFRS might
reflect a financial position, operating results and cash flows that are significantly
different from those presented in these financial statements. The implementation of IFRS
requires the Company to make suitable preparations, including the taking of certain
decisions relating to the manner of determining assets and liabilities at the transition
date and with regard to setting the accounting policy on various topics.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently assessing the implications of the transition to reporting under
IFRS. At this stage, the Company is unable to estimate what effect the adoption of IFRS
will have on its financial statements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Israeli
Accounting Standard No. 26 of the IASB  Inventory
| | -- | ------------------------------------------------------------

| | This
standard, which is based on International Accounting Standard No. 2 that deals with the
same issue, prescribes the accounting treatment of inventory and provides guidelines for
determining the cost of inventory and its subsequent recognition as an expense, including
the recognition and treatment of any write-down to net realization value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard specifies the costs that are to be taken into account in determining the cost of
inventory and the costs that may not be included in the cost of inventory, and requires
that fixed production overheads be allocated based on the normal capacity of the
production facilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
determining the cost of inventory, the standard provides for the specific identification
of the cost of certain items that are not ordinarily interchangeable and of goods and
services that have been produced and segregated for specific projects. In other
instances, the standard prescribes the exclusive use of the first-in, first-out (FIFO)
method or the weighted average method.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

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---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | The
standard also stipulates that the financing element in purchases of inventory that have
deferred settlement terms must be accounted for separately, whenever the actual
arrangement includes a financing element. For instance, the difference between the
purchase price for normal credit terms and the actual amount paid is to be recognized as
interest expenses over the financing period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard, which was issued in August 2006, shall be applicable to financial statements
for periods commencing on or after January 1, 2007.
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard will be applied retrospectively, but taking into account that the accounting
treatment applied to inventory by the Company in the past are not materially different
from the provisions of the standard, the initial implementation of the standard as above
will not have a material effect on the financial statements of the Company.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Israel Accounting
Standard No. 27  Property, Plant and  Equipment and
Israel Accounting Standard No. 28  Amendment of  the transition
provisions in Accounting Standard No. 27   Property, Plant
and Equipment 
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | accounting standard No. 27 
Property, Plant and Equipment, which is based on International Accounting
Standard No. 16, prescribes the accounting treatment for property, plant and
equipment. The standard stipulates provisions for the recognition of an item of property,
plant and equipment as an asset, the initial measurement of its cost, the measurement
subsequent to initial recognition, as well as provisions for the depreciation and
retirement of an item of property, plant and equipment.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the standard, an item of property, plant and equipment that qualifies for recognition
as an asset is to be measured at cost upon its initial recognition. The standard
determines that the cost of an item of property, plant and equipment includes the price
of its acquisition (including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates), costs directly attributable to bringing the asset
to the location and condition necessary for it to be capable of operating in the manner
intended by management, as well as the initial estimate of the costs of dismantling and
removing the item and restoring the site on which it is located (if the entity is
obligated to do so). 



The cost of an item of property,
plant and equipment is the cash price equivalent at the recognition date. Accordingly, if
payment is deferred beyond normal credit terms, the difference between the cash price
equivalent and the total payment is recognized as interest over the period of credit.



Subsequent to the date of the initial recognition, the standard
allows a choice between the cost method and the revaluation method as the accounting
policy, which must be applied to an entire class of property, plant and equipment. Under
the cost method, an item of property, plant and equipment shall be carried at its cost,
less any accumulated depreciation and any accumulated impairment losses. Under the
revaluation method, an item of property, plant and equipment whose fair value can be
measured reliably shall be carried at a revalued amount, being its fair value at the date
of the revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

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---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | An
increase in the carrying amount of an item of property, plant and equipment, resulting
from a revaluation, is to be credited directly to equity under the heading of Revaluation
surplus. However, such increase shall be recognized in profit or loss to the extent
that it reverses a revaluation decrease of the same asset previously recognized in profit
or loss. On the other hand, a decrease in the carrying amount of an item of property,
plant and equipment, resulting from a revaluation, is to be recognized in profit or loss.
However, the decrease shall be debited directly to equity under the heading of Revaluation
surplus, to the extent of any credit balance existing in the revaluation surplus in
respect of that asset.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard discusses the definition of the depreciable amount of an item of property, plant
and equipment, its residual value and the period and method of depreciation. The standard
stipulates that, for the purpose of depreciation of the property, plant and equipment,
the amount of the initial recognition should be allocated, to each part of an item of
property, plant and equipment with a cost that is significant in relation to the total
cost of the item, with each such significant part being depreciated separately, although
it is possible to group different parts of an item of property, plant and equipment with
the same useful life and depreciation method. According to the provisions of the
standard, the depreciation method should be reviewed at least once every fiscal year; if
there has been a significant change in the expected pattern of consumption of the future
economic benefits embodied in the asset, the method shall be changed to reflect the
changed pattern. Such a change shall be accounted for as a change in an accounting
estimate.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard, which was issued in September 2006, is to be applied to financial statements
for periods commencing on or after January 1, 2007, and is to be applied prospectively,
with two exceptions. First, for a company that, upon the adoption of the standard,
chooses the revaluation method as its accounting policy, the difference between the
revalued value of the asset as of January 1, 2007 and its carrying value shall
represent the revaluation reserve as of said date. Second, if the initial cost of the
asset does not include any removal and disposal costs, the specific transitional
provisions stipulated in the standard should be applied.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company elected the cost model as the accounting policy regarding measurement of
property, plant and equipment.
| | -------------------------------------------------------------------------------------------------------------------

| | The Company will apply, commencing
January 1, 2007, the provisions of Accounting Standard No. 27 retrospectively; but taking
into account that the accounting treatment applied to property plant and equipment by the
Company in the past is not materially different from the provisions of the standard,
first-time application of the standard as above will not have a material effect on the
financial statements of the Company.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Israeli
Accounting Standard No. 16 of the IASB- Investment Property
| | -- | ---------------------------------------------------------------------

| | In
February 2007, the IASB issued Israel Accounting Standard No. 16 - Investment
Property, which is based on International Accounting Standard No. 40. This
standard prescribes the accounting treatment applicable to investment property. The
standard sets provisions for the recognition, measurement and disclosure required for
investment property in the financial statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | According
to the standard, investment property is property held to earn rentals or for capital
appreciation or both, rather than for: (a) use in the production or supply of goods or
services or for administrative purposes; or (b) sale in the ordinary course of business.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard stipulates that investment property, which qualifies as an asset, is to be
measured at cost upon its initial recognition. According to the standard, the cost of an
investment property comprises its purchase price and other directly attributable
expenditures (such as fees for legal services, transfer taxes and other transaction
costs).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to the date of initial recognition, the standard allows a choice between the cost model
and the fair value model as an accounting policy, which must be applied to all investment
property items of the entity. According to the standard, transition from one model to the
other is only allowed if such transition results in a more appropriate presentation in
the financial statements. The standard states that this is not highly likely to be the
case when transition is from the fair value model to the cost model.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the cost model, the entity shall account for investment property in accordance with the
cost model specified in Israeli Accounting Standard No. 27 of the IASB- Property,
Plant and Equipment, pursuant to which the investment property is to be carried at
depreciated cost (net of accumulated impairment losses).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the fair value model, subsequent to initial recognition, the entity shall measure all
of its investment property at fair value as of the balance sheet date. Gains or losses
resulting from changes in fair value are carried to the statement of income in the period
in which they arise. In exceptional cases, when fair value cannot be reliably
determinable for certain investment property items, and the entity has elected the fair
value model as an accounting policy for its investment property, such specific items
shall be accounted for using the cost model, despite the application of the fair value
model to the other investment property items.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
standard shall be applicable to financial statements for periods commencing on January 1,
2007 or thereafter. Election of the fair value model would require the adjustment of the
opening balance of retained earnings for the period in which the standard is first
adopted.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company has elected to account
for its investment property in accordance with the fair value model, commencing the date
in which the standard became effective. Accordingly, the difference between the fair value
of the investment property as of January 1, 2007 and it depreciated cost at that date, in
an amount of approximately NIS 75,969 thousand before tax (NIS 50,598 thousand, net of tax
and other liabilities) (unaudited) will be carried to retained earnings. In accordance
with the provisions of the standard, since in previous periods no public disclosure was
given to the fair value of Companys investment property, the Company will not
restate comparative figures for previous periods. Gains and losses arising from changes in
the fair value of the investment property, commencing January 1, 2007, will be carried to
the statements of income (loss).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | 5. | Israeli
Accounting Standard No. 23 of the IASB  Accounting Treatment Applied to
Transactions between an Entity and its Controlling Shareholder.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2006, the IASB issued Accounting Standard No. 23  Accounting
Treatment Applied to Transactions between an Entity and its Controlling Shareholder
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard, which does not obligate entities that are not subject to the Securities Law,
1968, provides that assets and liabilities, in respect of which a transaction was carried
out between an entity and its controlling shareholder, shall be measured at the date of
transaction at their fair value, and the difference between fair value and the
consideration set in the transaction shall be carried to shareholders equity. Those
provisions replace the requirements of the Securities Regulations (Presentation of
Transactions between an Entity and its Controlling Shareholder in Financial Statements),
1996, whereunder, assets transferred as above would be measured at their carrying amount
in the transferors accounts, while the difference between this value and the
consideration set in those transactions is carried to shareholders equity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the provisions of the standard, in case the difference between fair value and the
consideration arises from a benefit granted by the controlling shareholder to the entity
controlled thereby, the said difference shall be credited to capital surplus within the
entitys shareholders equity; while in case the said difference arises from a
benefit granted by the entity to its controlling shareholder, such difference shall be
carried to the entitys retained earnings. In addition, the difference between the
fair value of the asset and its carrying amount in the transferors accounts shall
be recognized as a gain or loss in the transferors accounts.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the standard, differences as above, arising in the financial statements of an entity as a
result of a transaction with its controlling shareholder, and carried to retained
earnings or capital surplus, shall constitute, from the controlling shareholders
point of view , an owners withdrawal or an owners investment, respectively,
and shall be presented accordingly in the financial statements of the controlling
shareholder.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard includes specific provisions pertaining to assets transfers, assuming
liabilities, indemnification and waiver and the grant or receipt of loans. The standard
also sets a hierarchy for the measurement of fair value and includes disclosure
requirements as to the nature and scope of transactions between an entity and its
controlling shareholder, occurring during the reported period, as well as to the effect
of these transactions on the entitys income or loss for the reported period and its
financial position.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard shall apply to all transactions taking place between an entity and its
controlling shareholder, except for a business combination under common control, that
would be carried out subsequent to January 1, 2007. In addition, the standard would apply
to a loan granted to a controlling shareholder or received therefrom, prior to the
abovementioned effective date of the standard; the standard would apply to such a loan
commencing the standards effective date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The  application  of the  standard  will not have a
                       material effect on the financial statements of the Company, as of January 1, 2007.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | 6. | Israel
Accounting Standard No. 30  Intangible Assets
| | -- | -------------------------------------------------------

| | Accounting
Standard No. 30, which is based on International Accounting Standard No. 38,
prescribes the accounting treatment for intangible assets that are not covered by other
accounting standards. The standard stipulates how to measure the carrying amount of such
assets, and prescribes extensive disclosure requirements in respect thereof.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard discusses the various cases in which an entity may recognize an intangible
asset: separate acquisition, acquisition as part of a business combination, acquisition
by way of a government grant, exchange of assets and generating an internal intangible
asset. With respect to the latter, the standard determines that an intangible asset
arising from research shall not be recognized as an asset, while an intangible asset
arising from development shall only be recognized as an asset if the entity can prove
compliance with cumulative conditions detailed in the standard, including technological
feasibility of its completion in order for it to be available for use or sale, as well as
proving the manner in which it is to generate probable future economic benefits.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the standard, an intangible asset that qualifies for recognition as
an asset shall be initially measured at cost. Subsequent to the date of initial
recognition, the standard allows a choice between the cost model and the revaluation
model as an accounting policy, which must be uniformly applied to all items within a
given class. The revaluation model may only be used if an active market for the asset
exists.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the cost model, subsequent to initial recognition, an intangible asset shall be carried
at its cost, less any accumulated amortization (for assets with definite useful lives)
and any accumulated impairment losses. Under the revaluation model, an intangible asset
shall be carried at a revalued amount, being its fair value at the date of revaluation,
less any subsequent accumulated amortization and any subsequent accumulated impairment
losses. The fair value of an intangible asset is based on the existence of an active
market; in the absence of an active market, the asset will be measured in accordance with
the cost model.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard discusses the evaluation of whether the useful life of an intangible asset is
definite or indefinite, as well as the amortization period, amortization method and the
residual value of an intangible asset with a definite useful life. According to the
standard, the period and method of amortization of an intangible asset with definite
useful life shall be reviewed, at least at each fiscal year-end. In addition, an
intangible asset with indefinite useful life shall not be amortized, and should be tested
for impairment at least once a year, or more frequently, in the presence of events or
circumstances indicating a possible impairment in the value of such asset.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
accounting standard is applicable to financial statements for periods commencing on
January 1, 2007 or thereafter, and is applied by way of retrospective application,
except as stated below. The standard shall apply to business combinations carried out on
January 1, 2007 and thereafter. However, the standard prescribes specific
transitional provisions for the recognition as an asset of an in-process research and
development project, acquired as part of a business combination that was carried out
prior to January 1, 2007.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | Accounting
Standard No. 30 nullifies the provisions of Standard No. 20 (As Amended) Accounting
Treatment of Goodwill and Intangible Assets Arising upon an Acquisition of an Investee
Company relating to intangible assets (except for goodwill) arising upon an
acquisition of an investee company.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company elected the cost model as its accounting policy regarding measurement of
intangible assets.
| | -------------------------------------------------------------------------------------------------------

| | The
Company will apply the provisions of Accounting Standard No. 30 retrospectively;
Accordingly, first time application of the standard will result in the following change:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through the date of application of
the standard, the balance of property, plant and equipment included a balance of computer
softwares in an amount of NIS 6,551 thousand (unaudited) as of December 31, 2006. Upon
implementation of the standard, this balance of computer softwares will be classified
retrospectively to the intangible assets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | a. | Consolidated
subsidiary:
| | -- | ------------------------

| | In
May, 2005, the Company completed the purchase of 50% of the holding of Hamachsan
Hamerkazi Kfar Hashaashuim Ltd. (hereafter  Kfar Hashaashuim),
an Israeli company that operates non-food chain stores through franchises. The
acquisition cost of kfar hashashuim was allocated to its assets and liabilities
based on their fair value on the date of acquisition. The balance, in the amount of NIS
12.3 million, was allocated to goodwill which until December 31, 2005 was amortized at
the rate of 10% per annum (see note 2b(3)).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the purchase agreement, the Company has the right to appoint the majority of 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 Companys 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 cash payment of NIS
3.2 million for the shares and NIS 21.8 million, which was granted as a shareholder loan.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. In 2006, Kfar Hashaashuim decided
to repay NIS 3 million of the notes and the amount was classified as current matuities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 28

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# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | Following
are data relating to the abovementioned company included in the consolidated statements
of operations for the period from July 1 to December 31, 2005:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                               | For the period
from July 1, 2005 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  |                                                      
| |                               |                                                      

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

| | 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
          4.5%. The repayment date has not yet been determined.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 29

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

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

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

| |                    | *2004 | 2005 | 2006
| | ------------------ | ----- | ---- | ----
|
|
|
|
| | Revenues           |       |      |     
| | Costs and expenses |       |      |     
| | Net income (loss)  |       |      |     

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

| |                                                     | *2004 | 2005 | 2006
| | --------------------------------------------------- | ----- | ---- | ----
|
|
|
|
| | Net cash provided by operating activities           |       |      |     
| | Net cash provided by (used in) investing activities |       |      |     
| | Net cash used in financing 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | d. | Transfer
of real estate assets to a new subsidiary
| | -- | --------------------------------------------------

| | In
June 2006, the Company completed the transfer of its directly owned real estate assets
(excluding real estate owned by its subsidiary, BSIP) and certain liabilities, to a new
fully owned subsidiary  Blue Square Real Estate Ltd. (hereinafter BSRE).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | The
transfer of the real estate assets is effective as of December 31, 2005, and is in
accordance with the provisions of the Israel Tax Authoritys approval dated May 4,
2006, to the Companys application for a ruling, pursuant to sections 104A and
105A(2) of the Israeli Income Tax Ordinance. The Company leases from BSRE, for a period
of at least 10 years beginning on January 1, 2006, all the directly owned assets in which
it is currently operating stores.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to a prospectus dated August 16, 2006, BRSE made an offering of 2,500,000 BRSE ordinary
shares of NIS 1 par value each, together with NIS 100,000,000 par value of
registered BRSE Series A debentures, which are convertible into BRSE ordinary shares, and
NIS 650,000,000 par value of registered BRSE Series B debentures.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Series A debentures are to be
redeemed in four equal annual installments on August 31 of each year in the period
2013-2016 (inclusive). The Series A debentures are linked (principal and interest) to the
known Israeli consumer price index (CPI) and bear interest at an annual rate
of 6.25%, which is payable every six months, on February 28 and August 31 of each year
from 2007 until the final redemption of the debentures. The Series A debentures are
convertible into registered BSRE ordinary shares of NIS 1 par value from the date
that they are first listed for trade on the stock exchange through August 16, 2016, except
during the periods from August 17 through August 31 in each of the years between 2013-2015
(inclusive). Until August 31, 2008, the conversion will be effected at the rate of
NIS 100 par value of registered Series A debentures (NIS 99.12 par value, following
an adjustment on March 27, 2007) for each ordinary share of NIS 1 par value; after
that date and through August 16, 2016, the conversion rate will be NIS 300 par value
of registered Series A debentures (NIS 297.36 par value, following an adjustment on March
27, 2007) for each ordinary share of NIS 1 par value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Conversion rate is subject to adjustments in the event of distribution of cash dividends.
| | ---------------------------------------------------------------------------------------------

| | The
Series B debentures are to be redeemed in four equal annual installments on August 31 of
each year in the period 2013-2016 (inclusive). The Series B debentures are linked to the
known CPI and bear interest at an annual rate of 4.7%, which is payable every six months,
on February 28 and August 31 of each year from 2007 until the final redemption of the
debentures.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
offering was completed in August 2006 and BSRE received net proceeds of NIS 878,944
thousands (after deducting issuance expenses totaling NIS 32,465 thousands),
allocated as follow: NIS 622,995 thousand as debentures, NIS 108,231 thousand as
convertible debentures and NIS 147,559 thousands as equity.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company held 100% of the share capital of BSRE prior to the offering. Following the
offering, the Company holds 80% of the share capital of BSRE. In the event of full
conversion of the Series A debentures prior to August 2008, the Companys holdings
in BSRE would fall to approximately 74.1 %.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys capital gain from the aforesaid offering amounted to NIS 48,570
thousands, see note 15j.
| | ------------------------------------------------------------------------------------------------------

F - 31

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

| | e. | On
December 7, 2006, the Company completed the sale of approximately 0.7% of           BSIPs
share capital for a consideration of approximately NIS 11.3 million.           Due to
this sale, the Company recognized a capital gain of approximately NIS 6
          million, see note 15j.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company holds 80% of the share capital of BSIP.
| | ----------------------------------------------------------------------------

| | f. | As
to a commitment of the Company in connection with acquisition of Diners           Israel,
see note 9(b).
| | -- | -----------------------------------------------------------------------------------------------------------

| | g. | The
list of principal investee companies is presented in the appendix to the
          financial statements.
| | -- | ------------------------------------------------------------------------------------------------------------

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

| | a. | Composition
of assets and the accumulated depreciation and amortization           thereon, grouped by
major classifications, and changes therein in 2006, are as           follows:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | Land and
buildings
including
leasehold
land (1) | Leasehold
improvements | Furniture,
equipment
and
installations | Motor
vehicles | Total
| | ------------------------------- | ----------------------------------------------- | ---------------------- | -------------------------------------- | -------------- | -----
|
|
|
|
| | Cost:                           |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at January 1, 2006      |                                                 |                        |                                        | 1,808,405      |      
| | Additions                       |                                                 |                        |                                        | 21,336         |      
| | Disposals                       |                                                 |                        |                                        | (579           | )    
| | Changes due to acquisitions of  |                                                 |                       
| | subsidiaries consolidated for   |                                                 |                       
| | the first time                  |                                                 |                        |                                        | -              |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at December 31, 2006    |                                                 |                        |                                        | 1,829,162      |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Accumulated depreciation and    |                                                 |                       
| | amortization:                   |                                                 |                       
| |                                 |                                                 |                       
| | Balance at January 1, 2006      |                                                 |                        |                                        | 287,852        |      
| | Additions                       |                                                 |                        |                                        | 24,214         |      
| | Eliminated on disposals         |                                                 |                        |                                        | (379           | )    
| | Changes due to acquisitions of  |                                                 |                       
| | subsidiaries consolidated for   |                                                 |                       
| | the first time                  |                                                 |                        |                                        | -              |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Balance at December 31, 2006    |                                                 |                        |                                        | 311,687        |      
| |                                 |                                                 |                        |                                        |                |      
| | Impairment of fixed assets (see |                                                 |                       
| | b below)                        |                                                 |                        |                                        | 65,624         |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Net book value at December 31,  |                                                 |                       
| | 2006                            |                                                 |                        |                                        | 1,451,851      |      
| |                                 |                                                 |                        |                                        |                |      
| |                                 |                                                 |                       
| | Net book value at December 31,  |                                                 |                       
| | 2005                            |                                                 |                        |                                        | 1,436,421      |      
| |                                 |                                                 |                        |                                        |                |      

| | (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 - 32

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

| | During
2005 the Company recorded a further reversal of the impairment provisions resulting in
the net amount of NIS 0.1 million. This was the result of recording an impairment
provision of NIS 15.5 million in respect of certain stores, against which was offset the
reversal in the impairment provision in respect of other stores that had been recorded in
previous years in the amount of NIS 15.6 million.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2006 the Company recorded a reversal of the impairment provisions resulting in the net
amount of NIS 23.3 million. This was the result of recording provision of NIS 11.0
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 34.3 million.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Impairment
provisions or the reversal of such provisions are included in other income (expenses),
net, see note 15k.
| | --------------------------------------------------------------------------------------------------------------------

| | 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 impairment provision as of December 31, 2006 and 2005, 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, 2006:
| | -- | ----------------------------------------------------------------------------

| |                                                                                                                                                                 | NIS
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---
|
|
|
|
| | Ownership                                                                                                                                                       |    
| | Capitalized leaseholding for a period of 999 years                                                                                                              |    
| | Capitalized leaseholding from the Israel Land Administration
for periods ending 2010-2053 (including the option period
which is relevant for some of the lands) |    
| |                                                                                                                                                                 |    
| |                                                                                                                                                                 |    
| |                                                                                                                                                                 |    

F - 33

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

| | e. | As
to the changes in accounting treatment of fixed assets, which will take
               effect commencing January 1, 2007, as a result of applying Accounting
Standard                No. 27, Property, Plant and Equipment of the IASB
 see note                2x.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the change in accounting treatment of investment property, commencing January 1, 2007,
as a result of applying Accounting Standard No. 16 investment property of the
IASB  see note 2x.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 5 |  | OTHER
ASSETS:
|------ | - | -------------

| |                              | December 31,
| | ---------------------------- | ------------
|
|
|
|
| | Goodwill *)                  |             
| |                              |             
| | Deferred charges:            |             
| | Debenture issuance costs **) |             
| | Prepaid rental expenses and  |             
| | acquisition tax              |             
| |                              |             
| |                              |             
| |                              |             

| | *) | As
to the discontinued of amortization of goodwill, see note 2b(3).
| | -- | -------------------------------------------------------------------

| | **) | As
to the change in the accounting treatment of debenture issuance costs, see           note
2w.
| | --- | ------------------------------------------------------------------------------------------------

|NOTE 6 |  | LONG
-TERM LOANS FROM BANKS:
|------ | - | ----------------------------

| | a. | Composition:
| | -- | ------------

| |                           | Weighted
interest
rate | December 31,
| | ------------------------- | ---------------------- | ------------
|
|
|
|
| | In foreign currency:      |                        |             
| | Swiss Frank               |                        |             
| | In Israeli currency:      |                        |             
| | Linked to the Israeli CPI |                        |             
| | Unlinked (2)              |                        |             
| |                           |                        |             
| |                           |                        |             
| |                           |                        |             
| | Less - current maturities |                        |             
| |                           |                        |             
| |                           |                        |             
| |                           |                        |             

F - 34

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 6 |  | LONG
-TERM LOANS FROM BANKS (continued)
|------ | - | ---------------------------------------

| | (1) | Weighted
average intrest rate as of December 31, 2006.
| | --- | ------------------------------------------------------

| | (2) | As
of December 31, 2006 includes approximately NIS 96 million at variable           interest
(average annual rate as of December 31, 2006  5.83%, for the           major part
of these loans, based on PRIME minus 0.32%). The balance of           approximately NIS
19 million is at a fixed annual interest rate of 6.7%.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | The
balance outstanding at December 31, 2005 includes a loan in the amount of           NIS
500 million which was taken in connection with the real estate           reorganization
(see note 3d), which was repaid in August 2006.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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                      |            
| |                                 |            
| |                                 |            
| |                                 |            

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES:
|------ | - | --------------------------------------

| | a. | composition
| | -- | -----------

| |                           | December 31
| | ------------------------- | -----------
|
|
|
|
| | Convertible debentures:   |            
| | Issued by the Company     |            
| | Issued by BSRE (1)        |            
| |                           |            
| |                           |            
| |                           |            
| | Less - current maturities |            
| |                           |            
| |                           |            
| |                           |            
| |                           |            
| | Other debentures:         |            
| | Issued by the Company     |            
| | Issued by BSRE (1)        |            
| |                           |            
| |                           |            
| |                           |            
| | Less - current maturities |            
| |                           |            
| |                           |            
| |                           |            

| | (1) | see
note 3d.
| | --- | ------------

F - 35

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES (continued):
|------ | - | --------------------------------------------------

| | b. | In
August 2003, the Company issued NIS 400 million par value debentures to
          institutional investors in consideration for their par value as follows:
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | 200
million registered debentures (Series A) of NIS 1 par value each.
| | --- | ---------------------------------------------------------------------

| | These
debentures are linked (principal and interest) to the Israeli CPI, but in the event 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
one third of the par value of these debentures outstanding as of December 31, 2006, was
classified as current liabilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | 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, 2006 the conversion ratio
is that each NIS 30.079 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).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the conversion of debentures into company shares in the course of 2006 and subsequent
to the balance sheet date, see note 10c.
| | ------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 7 |  | DEBENTURES
AND CONVERTIBLE DEBENTURES (continued):
|------ | - | --------------------------------------------------

| | c. | 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 was less than 3.5, and
for           the period from the aforementioned date, the ratio is less than 3.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | The
ratio between the carrying amount of 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, 2006, the Company meets the aforementioned financial covenants.
| | ----------------------------------------------------------------------------------

| | d. | As
to the changes in the presentation of debentures, commencing January 1, 2006
          see also note 2k.
| | -- | -----------------------------------------------------------------------------------------------------------

F - 37

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 8 |  | LIABILITY
FOR EMPLOYEE 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 25-30 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 |             
| |                                               |             
| |                                               |             
| |                                               |             
| |                                               |             

| | The
Company may only make withdrawals from the severance pay funds for the purpose of paying
severance pay.
| | -----------------------------------------------------------------------------------------------------------

F - 38

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

F - 39

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS (continued):
|------ | - | --------------------------------------------------

| | 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
August 2006, the Anti-Trust Tribunal approved an agreed  upon order, under section
50B of the Trade Restrictions Law between the Director and dominant food suppliers. The
agreed-upon order 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
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 an internal enforcement program and to its opinion is acting
accordingly.
| | -------------------------------------------------------------------------------------------------------

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

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

F - 40

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS (continued):
|------ | - | --------------------------------------------------

| | 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 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. On February 2007, the parties reached a
settlement agreement according to which the Company will pay the plaintiff NIS 50
thousand to cover his expenses and his attorneys fees and will reimburse the
plaintiff the sum of NIS 30 thousand plus VAT that was paid by him, according to the
district courts judgment.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 41

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS (continued):
|------ | - | --------------------------------------------------

| | 8. | In
February 2004, the Company received tax assessments for the years 1999-2001.
               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 (hereafter  ITA)
with respect to most of the disputes. With respect to disputes that have not yet been
settled with the ITA, the company received orders from the ITA for tax years 1999-2001,
which disallowed financial expenses claimed by the Company. The amount of tax in dispute
is approximately NIS 8 million.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June 21, 2005, the Company appealed these orders to the District Court. The appeal
is still pending.
| | -------------------------------------------------------------------------------------------------------

| | In
November 2006, the Israeli Supreme Court issued a decision that finance expenses for
loans incurred for the purpose of distributing a dividend are not recognizable for tax
deduction purposes (with limited exceptions). Since the Company received final tax
assessments for tax years through 2002, any dividend distribution made from 2003 may be
subject to scrutiny by the Israeli Tax Authorities, which may determine that certain
loans were deemed to have been incurred for the purpose of distributing dividends, as a
result of which the finance expenses associated with such loans may be disallowed for tax
purposes.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the opinion of the Company and its legal advisors, the provisions included in the Companys
financial statements are sufficient to cover the potential liabilities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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
August 2006, the ITA issued decrees demanding payment of 22 million NIS for the years
2001-2002. The Company filed an appeal to the District court in Tel Aviv on September
2006 and the appeal is pending.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the opinion of the Company and its advisors, the provisions included in the financial
statements are sufficient for covering the potential liabilities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

F - 42

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS (continued):
|------ | - | --------------------------------------------------

| | b) | Commitments:
| | -- | ------------

| | 1. | On December 26, 2006, all conditions
precedent for the completion of the agreement between the Company and Dor Alon Energy
(1988) Ltd., a related party, (hereafter  Dor Alon), the first party, and Cal 
Israel Credit Cards Ltd. (hereafter  CAL) and Diners Club Israel Ltd (hereafter
 Diners Israel), a subsidiary of CAL, the second party, were satisfied. According to
the said agreement, the Company and Dor Alon jointly purchased from CAL 49% of the issued
share capital of Diners in consideration for a total amount of approximately NIS 21.3
million (hereafter  the Consideration). The holdings of the Company and Dor Alon in
the issued share capital of Diners are as follows: The Company  36.75% and Dor Alon
 12.25%. The consideration was financed through a non recourse loan provided by CAL
to the Company and Dor Alon. The loan is for a period of 8 years, and it is linked to the
CPI and bears interest in an annual rate of 6%. The loan will be repaid in a single
payment at the end of the period. The loan and interest are secured only by the shares of
Diners. Both parties can cancel the agreement if, at the end of a period of 4 years and/or
6 years, the number of cards will not exceed a pre-agreed quantity, as set in the
agreement, or if the loyalty plan ceases to function or the customer club agreement
(referred to in a. below) is terminated. 
According to the agreements, the
Company and Dor Alon are entitled to receive income arising from the activity of the
loyalty program, in proportion to their holdings in the shares of Diners. The entitlement
of the Company and Dor Alon to participate in the income from that activity of Diners,
which is not part of the loyalty programs activity, is contingent upon meeting some
milestones in defined periods of times as specified in the agreement. As of the date of
this report, the entitlement has not yet been established as aforementioned, and hence,
the Company has not presented its share in the investment in Diners, and in conjunction,
no liability was recorded in respect of its share in the said loan. The Company and Dor
Alon will be entitled, under certain conditions and during a pre-defined period, to
purchase the right to participate in the income of Diners, against a one-time payment.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company entered two additional agreements:
| | -----------------------------------------------------------

| | a. | An
agreement between the Company and Dor Alon for the establishment of a joint
          loyalty club for the benefit of the customers of the Company and Dor Alon under
          the brand name YOU (hereafter  the Loyalty Program) that has
          been incorporated as a partnership of the Company (75%) and Dor Alon (25%)
          (hereafter  the Customers Club).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
agreement of the Company and Dor Alon with Diners Israel prescribes that           the
members of the Customers Club will receive a Diners credit card, and
          defines the cooperation between the customers club and Diners, and
          includes accompanying agreements to the said agreement.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
agreement determines, among other things, the division of costs between the partnership
and Diners in respect of the costs of attracting new customers to the loyalty program,
mailing and advertising costs including the participation of Diners in the advertising
budget of the loyalty program, and clearing fees.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | 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 100 million, NIS 109 million,           and NIS 119
million for the years ended December 31, 2004, 2005 and 2006,           respectively.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 9 |  | CONTINGENT
LIABILITES AND COMMITMENTS (continued):
|------ | - | --------------------------------------------------

| | Future
minimum payments under non-cancelable operating leases for the years subsequent to
December 31, 2006, are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------

| |                           | NIS
in thousands
| | ------------------------- | ----------------
|
|
|
|
| | First year                |                 
| | Second year               |                 
| | Third year                |                 
| | Fourth year               |                 
| | Fifth year                |                 
| | Sixth year and thereafter |                 
| |                           |                 
| |                           |                 
| |                           |                 
| |                           |                 

| | 3. | As
of December 31, 2006, the Company has entered into agreements for the           purchase
of equipment and lease hold improvements, in the aggregate amount of
          approximately NIS 13.5 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 1.25 million, and to a third party in the
amount of NIS 0.7                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 6.1                million.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | A
subsidiary (Kfar Hashaashuim) and its investee companies granted
          guarantees to third parties in the amount of NIS 400 thousand.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------

|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, 2006 and 2005 21.2% and 21.6% of the outstanding Ordinary Shares of the
Company, respectively. As of December 31, 2006 the shares are quoted at $14.50 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, 2006 the shares are quoted at NIS 62.44 per
ordinary share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE10 |  | SHARE
CAPITAL (continued):
|------ | - | --------------------------

| | b. | Dividends:
| | -- | ----------

| | In
2006, the Company distributed dividends in the amount of approximately NIS 110 million.
| | ------------------------------------------------------------------------------------------

| | On April 19, 2007, the company
distributed a dividend in the amount of NIS 60 million (NIS 1.45 per share).
| | -----------------------------------------------------------------------------------------------------------

| | As  to the Board of Directors  decision  regarding
                     dividend distribution due to financial covenants, see note 7c(2).
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | c. | During
2006, company debentures with a par value of approximately NIS 22,857           thousand
were converted into 742,892 ordinary shares.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent  to the balance  sheet date,  until May
31, 2007,  company  debentures with a par value of  approximately  NIS 77,730,159  thousand were converted
into 2,635,098 ordinary shares.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent  to  the   conversions   detailed
                     above, the companys  issued and outstanding  share capital is composed of 42,328,081
                     ordinary shares of NIS 1 par value each.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | In
2004, BSIP received 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,
2006,                Companys share in the balance of liabilities collateralized
amounts to NIS                1 million.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Kfar Hashaashuim and its investee companies placed unlimited,
               fixed and floating charges and a first ranking lien on the warehouse and
all its                assets, property, book debts, rent, goodwill, profits, revenues,
rights of                ownership and other benefits in favor of their liabilities to
banks amounting at                December 31, 2006, to NIS 55 million.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Further
to Note 3d above, as of the date of December 31, 2006 charges have been
               registered in favor of BSRE. on five of the transferred properties for the
               purpose of securing the liabilities of the vendors of the above properties
               acquired by the Company vis-à-vis third parties (mainly banks). In
               addition, such charges have been registered on twelve further properties
from                amongst the properties transferred. In the latter case, however, the
Company has                received exclusion letters (hereinafter  the
conditional                exclusion letters) from the holders of the above
charges. The                Company has advised BSRE. that it has abided by, or will
abide by, the terms of                the conditional exclusion letters, and
that there is no significant                impediment to the completion of their
transfer to BSRE. The Company has also                acknowledged its obligation with
respect to the removal of the liens on the five                other properties, and has
acknowledged that it does not see any significant                impediment to the
removal of those liens.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME:
|------- | - | ----------------

| | a. | Corporate
taxation in Israel
| | -- | ----------------------------

| | a. | 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 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Capital
gains (other than the real capital gain on the sale of marketable securities  which
is subject to tax at the regular rates) are taxed at a reduced rate of 25% on the capital
gains derived after January 1, 2003, and at the regular corporate tax rates on the
gains derived through the aforementioned date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 46

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME  (continued):
|------- | - | -----------------------------

| | 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, 2005      |                                   |  | 
|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    |                                   |  | 
|                                |                                   | 
|Changes in 2006:                |                                   | 
|Amounts carried to income       |                                   |  | 
|Additions of deferred taxes in  |                                   | 
|respect of company consolidated |                                   | 
|for the first time              |                                   |  | 
|                                |                                   |  | 
|                                |                                   | 
|Balance at December 31, 2006    |                                   |  | 
|                                |                                   |  | 

| | 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      |            
| | Depreciation during the year |            
| |                              |            
| | Balance as of December 31    |            
| |                              |            

F - 47

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME  (continued):
|------- | - | -----------------------------

| | 3) | Deferred
taxes are presented in the balance sheets as follows:
| | -- | --------------------------------------------------------------

| |                           | December 31
| | ------------------------- | -----------
|
|
|
|
| | Other accounts receivable |            
| | Long term deferred taxes  |            
| | Long-term liabilities     |            
| |                           |            
| |                           |            
| |                           |            

| | Realization
of this deferred tax assets is conditional upon earning, in the coming years, taxable
income in appropriate amounts.
| | --------------------------------------------------------------------------------------------------------------------------------

| | The
deferred taxes are computed at the tax rates of 25%-29%.
| | ------------------------------------------------------------

| | c. | As
of December 31, 2006 and 2005 the Company and its subsidiaries have operating
tax loss carryforwards of approximately NIS 9.3 and NIS 5.6 million,
respectively. In addition, the Company and its subsidiaries have capital loss
tax carryforwards of approximately NIS 17.7 million and NIS 24 million
respectively. The tax benefit in respect of capital tax loss carryforwards
amounting to NIS 10.4 million has not been recorded due to uncertainty of their
realization.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Taxes
on income included in the statements of operations:
| | -- | ---------------------------------------------------------

| | 1. | As
follows:
| | -- | -----------

| |                                           | 2004 | 2005 | 2006
| | ----------------------------------------- | ---- | ---- | ----
|
|
|
|
| | In respect of the reported year:          |      |      |     
| | Current                                   |      |      |     
| | Deferred:                                 |      |     
| | In respect of changes to tax rates,       |      |     
| | see 12a(2) above                          |      |      |     
| | In respect of the reporting period        |      |      |     
| | Tax expense (benefit) in respect of prior |      |     
| | years:                                    |      |     
| | Current                                   |      |      |     
| | Deferred                                  |      |      |     
| |                                           |      |      |     
| |                                           |      |     
| |                                           |      |      |     
| |                                           |      |      |     

| | Current
taxes are computed in 2004 at a tax rate of 35%; in 2005  34%; in 2006  31%
(see 12a(2) above).
| | ---------------------------------------------------------------------------------------------------------

F - 48

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 12 |  | TAXES
ON INCOME  (continued):
|------- | - | -----------------------------

| | 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:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                                                                                       | 2004 | 2005 | 2006
| | ------------------------------------------------------------------------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Income before taxes on income, as reported in                                                                                         |      |      |     
| | the consolidated 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 benefit recorded for the first time on                                                                                            |      |     
| | carryforward capital loss                                                                                                             |      |      |     
| | Decrease in taxes resulting from computation of
   deferred taxes at a rate which is different
   from the theoretical rate           |      |      |     
| | Tax expense 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*                                                                                                |      |      |     
| | Capital gain from the offering of BSRE which in
   respect, tax benefit has not been recorded                                         |      |      |     
| |                                                                                                                                       |      |      |     
| |                                                                                                                                       |      |     
| | Income tax expense                                                                                                                    |      |      |     
| |                                                                                                                                       |      |      |     

| | * | Including
decrease in taxes in the amount of NIS 2,973, NIS 172 thousands and increase of NIS 104
thousand in 2004, 2005 and 2006 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).
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 also note 9a(8). Some of the principal           subsidiaries
have received final assessments for tax years through 2002. 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).
| | -- | -------------------------------------------------------------------

F - 49

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 13 |  | TERMS
OF FINANCIAL INSTRUMENTS:
|------- | - | -------------------------------

| | a. | Currency
risks
| | -- | --------------

| | The
functional currency for most of the Companys operations is the New Israel Shekel.
The Company and its subsidiaries are parties to a number of rental contracts linked to
foreign currencies, the principle of which is the U.S. dollar. The Company does not
undertake hedging operations involving derivative instruments with respect to the
exposure that may arise.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Index
risks
| | -- | -----------

| | The
Company and a subsidiary have issued debentures and loans linked to the Consumer Price
Index. Each change in the index affects the level of the Companys financing
expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Credit
risks
| | -- | ------------

| | The
Companys sales are derived from a large number of customers in Israel 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, 2006. 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Interest
risks
| | -- | --------------

| | The
interest rate risk of the Company and its subsidiaries stems from long-term loans which
bear fixed rates of interest and are exposed to fair value risk arising from interest
rate changes, and from long-term loans that are unlinked and bear interest at variable
rates and which are exposed to cash flow risk arising from interest rate changes (see
note 6 above). The Company invests its surplus cash in unlinked shekel deposits, and
accordingly, any decrease in the interest rate has a corresponding effect on the increase
in the Companys net financing expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Price
risk
| | -- | ----------

| | The
Company invests in marketable securities (government and corporate debentures) and is
accordingly exposed to risks arising from the expected market fluctuations (interest and
index) associated with this type of investment. The investments in question are
classified as current investments and are presented at their market value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 50

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 13 |  | TERMS
OF FINANCIAL INSTRUMENTS (continued):
|------- | - | -------------------------------------------

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

| | 1. | The
following table sets out the value of financial instruments in the           accounting
records, and the fair value of groups of financial instruments (these           financial
instruments are not reflected in the financial statements at fair           value):
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                             | December 31, 2006 | December 31, 2005
| | --------------------------- | ----------------- | -----------------
|
|
|
|
| | Financial liabilities:      |                   |                  
| | Long-term loans, including: |                   |                  
| | Current maturities (1)      |                   |                  
| | Debentures (2)              |                   |                  

| | (1) | The
fair value of the above loans is based on the calculation of the present           value
of the cash flows, as discounted at that market rate of interest           applicable to
similar loans bearing similar characteristics (2006  4.5%,           2005  5.2%).
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
fair value is based on quoted prices in an active market on the date of the
          balance sheet, for marketable debentures and on the calculation of the present
          value of the cash flows, as discounted at that market rate of interest
          applicable to similar debentures bearing similar characteristics (2006           4.5%,
2005  5.2%), for non-marketable debentures.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | 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 - 51

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 14 |  | LINKAGE
OF MONETARY BALANCES:
|------- | - | -----------------------------

| | a. | As
follows:
| | -- | -----------

| |                                             | December 31, 2006
| | ------------------------------------------- | -----------------
|
|
|
|
| | Current assets:                             |                  
| | Cash and cash equivalents                   |                  
| | Short-term investments                      |                  
| | Trade receivables                           |                  
| | Short term deposit                          |                  
| | Other accounts receivable                   |                  
| | Investments and long-term receivables:      |                  
| | 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                      |                  
| |                                             |                  
| |                                             |                  
| |                                             |                  

| | b. | Data
regarding the exchange rate and the CPI:
| | -- | ---------------------------------------------

| |                                      | Exchange 
rate of one
U.S. dollar | CPI*        
| | ------------------------------------ | --------------------------------- | ------------
|
|
|
|
| | At end of year:                      |                                   |             
| | 2006                                 | NIS 4.225                         | 109.9 points
| | 2005                                 | NIS 4.603                         | 110.0 points
| | Increase (decrease) during the year:
| | 2006                                 | (8.2)%                            | (0.1)%      
| | 2005                                 | 6.8%                              | 2.4%        
| | 2004                                 | (1.6)%                            | 1.1%        

| | * | Based
on the index for the month ending on each balance sheet date, on the basis of 2000
average = 100.
| | - | -------------------------------------------------------------------------------------------------------

F - 52

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION:
|------- | - | -----------------------------------------------

| | Balance
sheets:
| | ---------------

| | a. | Marketable
securities:
| | -- | ----------------------

| |                        | December 31,
| | ---------------------- | ------------
|
|
|
|
| | Government debentures  |             
| | Debentures of concerns |             
| |                        |             
| |                        |             
| |                        |             
| |                        |             

| | b. | Trade
receivables:
| | -- | ------------------

| |                                        | December 31,
| | -------------------------------------- | ------------
|
|
|
|
| | Credit card receivables                |             
| | Open accounts and checks receivables   |             
| |                                        |             
| |                                        |             
| |                                        |             
| | Less - allowance for doubtful accounts |             
| |                                        |             
| |                                        |             
| |                                        |             
| |                                        |             

| | c. | Other
accounts receivable:
| | -- | --------------------------

| |                                       | December 31,
| | ------------------------------------- | ------------
|
|
|
|
| | Deferred income taxes (see note 12b)  |             
| | Prepaid expenses                      |             
| | Government authorities                |             
| | Receivables from sale of fixed assets |             
| | Other                                 |             
| |                                       |             
| |                                       |             
| |                                       |             
| |                                       |             

| | d. | Inventories:
| | -- | ------------

| |                    | December 31,
| | ------------------ | ------------
|
|
|
|
| | Merchandise        |             
| | Parts and supplies |             
| |                    |             
| |                    |             
| |                    |             
| |                    |             

F - 53

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION (continued):
|------- | - | -----------------------------------------------------------

| | e. | Other
long-term receivables:
| | -- | ----------------------------

| |                    | December 31,
| | ------------------ | ------------
|
|
|
|
|
| | Long term loans *  |             
| | Checks receivables |             
| | Others             |             
| |                    |             
| |                    |             
| |                    |             

| | * | Including
loan granted to a third party amounting to NIS 1,788 thousands as of December 31, 2006.
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. | Credit
and loans from banks:
| | -- | ----------------------------

| |                                                    | December 31
| | -------------------------------------------------- | -----------
|
|
|
|
| | Short-term credit from banks                       |            
| | Current maturities of long-term Loans (see note 6) |            
| |                                                    |            
| |                                                    |            
| |                                                    |            

| | g. | Other
accounts payable and accrued expenses:
| | -- | --------------------------------------------

| |                                           | December 31
| | ----------------------------------------- | -----------
|
|
|
|
| | Payroll and related expenses and          |            
| | other employee benefits                   |            
| | Government authorities                    |            
| | Liability in respect of gift certificates |            
| | Accrued expenses and other                |            
| |                                           |            
| |                                           |            
| |                                           |            

| | h. | Minority
interest:
| | -- | ------------------

| |                                                                                            | December 31
| | ------------------------------------------------------------------------------------------ | -----------
|
|
|
|
| | Balance at beginning of the year                                                           |            
| |                                                                                            |            
| | Minority interest in profits of subsidiaries, net                                          |            
| | Dividend paid and to be paid to minority shareholders
   of subsidiaries                   |            
| | Additional minority interest related to acquisition of                                     |            
| | subsidiary consolidated for the first time                                                 |            
| | Additional minority interest related to realization and
   public offering of subsidiaries |            
| |                                                                                            |            
| |                                                                                            |            
| | Balance at end of the year                                                                 |            
| |                                                                                            |            

F - 54

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION (continued):
|------- | - | -----------------------------------------------------------

| | Statements
of operations:
| | -------------------------

| | i. | Selling,
general and administrative expenses:
| | -- | ---------------------------------------------

| |                           | 2004 | 2005 | 2006
| | ------------------------- | ---- | ---- | ----
|
|
|
|
| | Includes advertising, net |      |      |     
| |                           |      |      |     

| | j. | Financial
expenses, net:
| | -- | ------------------------

| |                                                | 2004 | 2005 | 2006
| | ---------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | In respect of:                                 |      |      |     
| | Long-term loans and debentures                 |      |      |     
| | Increase in value of marketable securities     |      |      |     
| | Interest income net of short-term credit, bank |      |     
| | commissions and others                         |      |      |     
| |                                                |      |      |     
| |                                                |      |     
| |                                                |      |      |     
| |                                                |      |      |     

| | k. | Other
income (expenses), net:
| | -- | -----------------------------

| |                                                                             | 2004 | 2005 | 2006
| | --------------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Termination benefits in respect of efficiency plan                          |      |      |     
| | Gain from realization of investments in investees                           |      |     
| | (see note 3 (c)(d)(e))                                                      |      |      |     
| | Gain (loss) from sale of fixed assets, net                                  |      |      |     
| | Impairment of assets, net (1)                                               |      |      |     
| | Costs in respect of closure of stores (lease   termination costs and other) |      |      |     
| | Compensation of termination of private label franchise                      |      |      |     
| | Other, net                                                                  |      |      |     
| |                                                                             |      |      |     
| |                                                                             |      |      |     
| |                                                                             |      |      |     

| | (1) | Mainly
reversal of impairment provision (impairment provision) in respect of           fixed
assets, see Note 4b.
| | --- | -----------------------------------------------------------------------------------------------------------------

F - 55

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES:
|------- | - | ----------------------------------

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

| |                     | 2004 | 2005 | 2006
| | ------------------- | ---- | ---- | ----
|
|
|
|
| | Directors' fees (1) |      |      |     
| | Legal consulting    |      |      |     
| | Consulting (2)      |      |      |     
| | Commissions (3)     |      |      |     
| | Discounts (4)       |      |      |     

| | 1) | Represents
payments in respect of directors fees.
| | -- | --------------------------------------------------

| | 2) | Represent
payments to S. Zohar in respect of consulting agreement signed on           June 2003
until 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) | 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 56

---

---



# BLUE SQUARE 
ISRAEL LTD.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (continued)

|NOTE 17 |  | SUBSEQUENT
EVENTS
|------- | - | -----------------

| | 1. | On
February 28, 2007, Kfar Hashaashuim signed an agreement with the
          controlling shareholders of Vardinon Textile Ltd (hereafter  Vardinon)
for           investment in vardinon, which is a public textile company traded in the Tel
Aviv           Stock exchange.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
accordance with the agreement, Kfar Hashaashuim will acquire up to 85.8% of Vardinons
shares in consideration for approximately NIS 37 million. This amount may change subject
to further adjustments, as determined in the agreement.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The  transaction  was completed  during the course
of April 2007.
| | -----------------------------------------------------------------

| | Kfar
 Hashaashuim  will  make a  further  payment for the shares in an amount
 equivalent  to 75% of the post-tax  profits of Vardinon for the first quarter of 2007,
 as  multiplied  by the  proportion  of that  companys  share  capital  being
 acquired  by Kfar Hashaashuim.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Kfar
 Hashaashuim  has taken a loan of  approximately  NIS 36 million for the
                            purpose of financing the acquisition.  The loan,  linked to
the Consumer Price                             Index and  bearing  interest at a rate of
5.45% per annum,  will be  repayable                             in  forty  monthly
  instalments.   The  terms  of  the  loan  impose  certain
                            constraints  on Kfar  Hashaashuim  with  respect  to
the sale of the  shares,                             together  with  various  other
 constraints  that  include a  requirement  for                             compliance
with covenants.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
April 2007, the Company  entered into a binding  agreement for the purchase
                            of  a  further  10%  of  the  issued  and  paid-up   share
  capital  of  Kfar                             Hashaashuim for a consideration of
approximately NIS 5 million.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
 completion of the  transaction,  the Company will hold 60% of the issued
                            and paid-up share capital of Kfar Hashaashuim.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|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:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | 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 include in the reconciliation to
US GAAP 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 57

---

---



# 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. | Deferred
income taxes
| | -- | ---------------------

| | a. | 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | In
accordance with Israeli GAAP, the Company concluded as of December 31 ,2006,
          that the recognition of a deferred tax liability relating to a capital gain of
          NIS 48,570 thousand arising from the offering of shares of BSRE was not
required           because the Company does not intend to sell its shares in BSRE.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to US GAAP, a deferred tax liability in the amount of NIS 12,143 thousands has been
recorded.
| | -------------------------------------------------------------------------------------------------------

| | 3. | Liability
for employee rights, net of amount funded
| | -- | ---------------------------------------------------

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

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

| | See
Note 8c for the presentation in the Companys balance sheet.
| | ----------------------------------------------------------------

| | 4. | 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. Therefore under US GAAP, changes in the fair value of
the derivative instruments are carried to Gains on derivatives.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | In
2006, the Company did not have hedging instruments.
| | ------------------------------------------------------

F - 58

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

| | In
addition under Israeli GAAP, lease agreements denominated in currencies other than the
functional currency are not considered arrangements with embedded derivatives.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to statement 133 Implementation issue B21 Embedded Derivatives, when Embedded
Foreign Currency Derivatives Warrant Separate Accounting, such agreements include
embedded derivatives which should be bifurcated and recorded as a liability. The fair
value of the embedded derivatives is valued at balance sheet date until the lease is
over.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Differences
in fair value were recorded as financial income and amounted to NIS 9,911 thousand (NIS
7,086 thousand after taxes) in 2006.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | 5. | Goodwill
| | -- | --------

| | Prior
to January 1, 2006 under Israeli GAAP, goodwill was amortized in equal annual
installments over a period of 10 and 20 years (see note 2b(3)), and 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 is tested for impairment at least annually (see note 2j).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, goodwill is not amortized. In addition, 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 59

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

| | 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 and exceeds fair value. The carrying amount is not
recoverable if it exceeds the estimated undiscounted future cash flows expected to result
from the use and eventual disposition of the asset. An impairment loss should be recorded
for the amount by which the carrying value of the asset exceeds its fair value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result, when the sum of the future discounted cash-flows of the long lived assets is
less than the carrying amount of such assets, but the undiscounted cash-flows is more
than the carrying amount, an impairment loss, will be recorded under Israeli GAAP, but
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 reversed in the
future, while under U.S. GAAP, this impairment loss cannot be reversed and the asset is
continued to be carried at its new cost.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7. | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | 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 - 60

---

---



# 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. | 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 2006, 2005 and 2004, the
conversion price was adjusted to NIS 30.08, NIS 32.89 and NIS 35.2, as of December 31,
2006, 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
2006, 2005 and 2004 a beneficial conversion feature (credited to additional paid-in
capital (APIC) amounting to NIS 21,045 thousand (NIS 14,748 thousand after
taking into consideration deferred taxes), 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, 2006, 2005 and 2004, additional interest expense in the amount of NIS 23,216
thousand (NIS 16,019 thousand after taxes), 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 28.6,  due to  announcement  of  another
                            dividend  distribution,  see note 17a. As a result, the Company is expected to
                            record  in 2007 an  additional  discount  on the  debentures,  in an amount of
                            approximately  NIS 8,007  thousand (NIS 5,773  thousand after taxes) against a
                            credit to APIC.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 61

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

| | Under
Israeli GAAP, the beneficial conversion feature component is not recognized in the
financial statements.
| | --------------------------------------------------------------------------------------------------------------

| | Under
the transition provisions of Israeli standard No.22, effective January 1, 2006, the
company is required to bifurcate the equity component from these convertible debentures,
see note 2k. However, the value assigned of the equity component, based on the
calculation guidelines outlined in standard No. 22 resulted in a non-material amount and
thus the amount of the liability was not bifurcated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
Israeli GAAP, the balance of the debt issuance costs have been reclassified and presented
as a deduction from the liability (note2w(3)).
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | Under
to US GAAP, debt issuance costs are presented as an asset and amortized using the
effective interest method over the life of the debt.
| | --------------------------------------------------------------------------------------------------------------------------------------------

| | Under
US GAAP, convertible debentures are accounted for in accordance with the provisions of
Emerging Issues Task Force (EITF) Issue No. 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys
Own Stock (EITF 00-19). The Company has also considered EITF No. 05-2,
The Meaning of Conventional Convertible Debt Instrument in the adoption of
EITF 00-19. Under these pronouncements, the Company has recorded the embedded derivative
instrument as a liability based on its fair value. The fair value of the derivative
instrument was determined using the bionomic valuation model. The remaining balance of
the proceeds was attributed to the debenture. The embedded derivative was bifurcated and
recorded as a liability in the amount of NIS 3,661 thousand as of August 20, 2006. The
fair value of the embedded derivative is valued at balance sheet date until the
conversion of the debentures. Difference in fair value, were recorded as financial
expenses and amounted to NIS 986 thousand in 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10. | 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.
| | -------------------------------------------------------------------------------------------------------------

| | 11. | Leasehold
rights from the Israel Land Administration Authority (ILAA)
| | --- | ---------------------------------------------------------------------

| | Under
Israeli GAAP, land lease rights from the ILAA are accounted for as fixed assets, and not
depriciated.
| | -----------------------------------------------------------------------------------------------------------

| | Under
US GAAP, in accordance with SFAS 13 Accounting for Leases, leases involving
real estate can be accounted for as capital lease only when (a) the lease transfers
ownership of the property to the lessee by the end of the lease term or (b) the lease
contains a bargain purchase option. Since none of the above-mentioned terms is met,
leasehold rights are accounted for as an operating lease. The leasehold rights are
amortized over the period of the initial option plus the renewal option period (See note
18c(6)).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 62

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

| | 12. | 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 2006, 2005 and 2004
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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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:
| | -- | --------------------------------------

| |                                                         | 2004 | 2005 | 2006
| | ------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Net income as reported, according to Israeli GAAP       |      |      |     
| | Amortization of goodwill ,see a (5)                     |      |      |     
| | Accretion of discount resulting from                    |      |     
| | beneficial conversion feature in                        |      |     
| | respect of convertible debentures ,see a (9)            |      |      |     
| | Gains on derivatives ,see a (4)                         |      |      |     
| | Impairment of long-lived assets ,see a (6)*)            |      |      |     
| | Amortization of leasehold rights from the ILAA see (11) |      |      |     
| | Financial expenses, net                                 |      |      |     
| | Taxes in respect of the above                           |      |      |     
| | Deferred taxes on income ,see a (2)                     |      |      |     
| | Minority interest in respect of the above               |      |      |     
| |                                                         |      |      |     
| | Net income according to U.S. GAAP                       |      |      |     
| |                                                         |      |      |     
| | Net income per share per Israeli GAAP:                  |      |     
| |                                                         |      |     
| | Basic                                                   |      |      |     
| |                                                         |      |      |     
| | Diluted                                                 |      |      |     
| |                                                         |      |      |     
| | Net income per share Per U.S. GAAP:                     |      |     
| | Basic                                                   |      |      |     
| |                                                         |      |      |     
| | Diluted                                                 |      |      |     
| |                                                         |      |      |     
| |                                                         |      |     
| | Weighted average number of shares used                  |      |     
| | for computation of earning per share                    |      |     
| |                                                         |      |     
| | Basic                                                   |      |      |     
| |                                                         |      |      |     
| | Diluted                                                 |      |      |     
| |                                                         |      |      |     

F - 63

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

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

| | 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, 2005 | December 31, 2006
| | ------------------------------ | ----------------- | -----------------
|
|
|
|
| | Other accounts receivable (4)  |                   |                  
| | Severance pay fund (3)         |                   |                  
| | Cost of fixed assets           |                   |                  
| | Accumulated depreciation       |                   |                  
| | and amortization               |                   |                  
| | (including impairment          |                   |                  
| | of fixed assets) (6) (11)      |                   |                  
| | Intangible assets and deferred |                   |                  
| | charges (5) (9)                |                   |                  
| | Deferred income taxes,         |                   |                  
| | net (2) (4) (6) (9) (11)       |                   |                  
| | Other accounts payable         |                   |                  
| | and accrued expenses (9)       |                   |                  
| | Accrued severance pay (3)      |                   |                  
| | Debentures and convertible     |                   |                  
| | debentures (9)                 |                   |                  
| | Minority interest *            |                   |                  
| | Additional paid-in             |                   |                  
| | capital (7) (9)                |                   |                  
| | Retained earnings **           |                   |                  
| | Total shareholders' equity     |                   |                  

| | * | Net
effect of reconciling items.
| | - | --------------------------------

| | ** | 2006
unappropriated are net of an adjustment of NIS 45,209 thousands, related to the adoption
of SAB 108 (see note 18c(6) below).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

F - 64

---

---



# 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(11) above.
| | --- | ----------------

| | c. | Recently
issued accounting pronouncements in the United Stats:
| | -- | --------------------------------------------------------------

| | 1) | In
February 2006, the Financial Accounting Standards Board (FASB)
               issued Statement of Financial Accounting Standards No. 155, Accounting for
               Certain Hybrid Financial Instruments (SFAS No. 155), which
amends                SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities                (SFAS No. 133) and SFAS No. 140, Accounting for
Transfers and                Servicing of Financial Assets and Extinguishments of
Liabilities (SFAS No.                140). SFAS No. 155 simplifies the
accounting for certain derivatives                embedded in other financial instruments
by allowing them to be accounted for as                a whole if the holder elects to
account for the whole instrument on a fair value                basis. SFAS No. 155 also
clarifies and amends certain other provisions of SFAS                No. 133 and SFAS No.
140. SFAS No. 155 is effective for all financial                instruments acquired,
issued or subject to a remeasurement event occurring in                fiscal years
beginning after September 15, 2006. Earlier adoption is permitted,
               provided the Company has not yet issued financial statements, including
for                interim periods, for that fiscal year. The Company is currently
evaluating the                impact of SFAS No. 155 on the Companys results of
operations and financial                condition.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 65

---

---



# 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) | In
March 2006 the FASB issued Statement of Financial Accounting Standards No.
               156, Accounting for Servicing of Financial Assets  an
amendment of                FASB Statement No. 140 (FAS 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. In                accordance with the provisions of FAS 156,
separately recognized servicing                assets and servicing liabilities must be
initially measured at fair value, if                practicable. Subsequent to initial
recognition, company may use either the                amortization method or the fair
value measurement method to account for                servicing assets and servicing
liabilities within the scope of this Statement.                FAS 156 is effective for
fiscal years beginning after September 15, 2006                (January 1, 2007, for the
company). Earlier adoption is permitted as of the                beginning of an entitys
fiscal year, provided the entity has not yet                issued financial statements,
including interim financial statements, for any                period of that fiscal
year. The Company is currently evaluating the impact of                SFAS No. 156 on
the Companys results of operations and financial                condition.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | In
June 2006, the FASB ratified EITF Issue No. 06-03 How Taxes Collected from
               Customers and Remitted to Governmental Authorities Should Be Presented in
the                Income Statement (That Is, Gross Versus Net Presentation) (Issue
No.                06-03). Under Issue No. 06-03, a company must disclose its
accounting                policy regarding the gross or net presentation of certain
taxes. If taxes                included in gross revenues are significant, a company must
disclose the amount                of such taxes for each period for which an income
statement is presented (i.e.,                both interim and annual periods). Taxes
within the scope of this Issue are those                that are imposed on and
concurrent with a specific revenue-producing                transaction. Issue No. 06-03
is effective for the first annual or interim                reporting period beginning
after December 15, 2006 (as of January 1, 2007 for                the Company). The
Companys current policy is to recognize revenue net of                VAT,
accordingly the Company does not expecting this new accounting
               pronouncement to materially effect the Companys results of
operations and                financial condition and disclosure.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | In
July 2006, the FASB issued Interpretation No. 48 (FIN No. 48),
               Accounting for Uncertainty in Income Taxes, which clarifies the accounting
for                uncertainty in income taxes recognized in the financial statements in
accordance                with FASB Statement No. 109, Accounting for Income Taxes. FIN
No. 48                prescribes a two-step process to determine the amount of tax
benefit to be                recognized. First, the tax position must be evaluated to
determine the                likelihood that it will be sustained upon examination. If
the tax position is                deemed more-likely-than-not to be
sustained, the tax position is                then measured to determine the amount of
benefit to recognize in the financial                statements. The tax position is
measured at the largest amount of benefit that                is greater than 50 percent
likely of being realized upon ultimate settlement.                FIN No. 48 also
provides guidance on various related matters such as                derecognition,
interest and penalties and disclosure. FIN No. 48 is effective                for fiscal
years beginning after December 15, 2006 (as of January 1, 2007 for                the
Company). The Company is currently evaluating the impact of FIN No. 48 on
               the Companys results of operations and financial condition.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 66

---

---



# 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)
|------- | - | ----------------------------------------------------------------------------------------------------------------------

| | 5) | In
September 2006 the FASB issued SFAS No. 157, Fair Value Measurements                (SFAS
No. 157), which provides guidance for using fair value to                measure
assets and liabilities. The standard also responds to investors               requests
for more information about (1) the extent to which companies measure
               assets and liabilities at fair value, (2) the information used to measure
fair                value, and (3) the effect that fair-value measurements have on
earnings. SFAS                No. 157 will apply whenever another standard requires (or
permits) assets or                liabilities to be measured at fair value. The standard
does not expand the use                of fair value to any new circumstances. SFAS No.
157 is effective for financial                statements issued for fiscal years
beginning after November 15, 2007, and                interim periods within those fiscal
years (as of January 1, 2008 for the                Company).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently evaluating the impact of SFAS No. 157 on the Companys results of
operations and financial condition.
| | ------------------------------------------------------------------------------------------------------------------------------

| | 6) | In
September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering
               the Effects of Prior Year Misstatements when Quantifying Misstatements in
               Current Year Financial Statements (SAB No. 108). SAB No. 108
               provides guidance on the consideration of the effects of prior year
               misstatements in quantifying current year misstatements for the purpose of
a                materiality assessment. SAB 108 establishes an approach that requires
               quantification of financial statement errors based on the effects of each
of the                companys balance sheet and statement of operations and the
related                financial statement disclosures. SAB No. 108 permits existing
public companies                to record the cumulative effect of initially applying
this approach in the first                year ending after November 15, 2006 by
recording the necessary correcting                adjustments to the carrying values of
assets and liabilities as of the beginning                of that year with the
offsetting adjustment recorded to the opening balance of                retained
earnings. Additionally, the use of the cumulative effect transition                method
requires detailed disclosure of the nature and amount of each individual
               error being corrected through the cumulative adjustment and how and when
it                arose. The Company has adopted SAB No. 108. The adoption of SAB
No. 108 had                an effect of NIS 45,209 thousand on the consolidated retained
earnings due to                the GAAP differences related to the leases from the
Israeli administration, see                note a(11) above.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7) | In
 February  2007,  the FASB  issued  SFAS No.  159,  The Fair Value  Option for
 Financial  Assets and Financial  Liabilities,  Including an Amendment of FASB Statement
No. 115, which will become effective in 2008. SFAS No. 159 permits entities to
measure eligible financial assets,  financial  liabilities and firm commitments at fair
value, on an  instrument-by-instrument  basis,  that are otherwise not permitted to be
accounted  for at fair  value  under  other  generally  accepted  accounting  principles.
 The fair  value measurement  election is irrevocable  and  subsequent  changes in fair
value must be recorded in earnings. The  Company  has not yet  determined  the  effect
 that the  adoption  of SFAS No.  159 will  have on its consolidated financial
statements.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 67

---

---



APPENDIX I

# BLUE SQUARE 
ISRAEL LTD.

DETAILS OF PRINCIPAL
SUBSIDIARIES, PROPORTIONATELY CONSOLIDATED COMPANIES AND AN ASSOCIATED COMPANY AT DECEMBER
31, 2006

|Holding Company               | Name of Company | Percentage of
ownership and
control by holding
company as of
December 31,
2006 |                                        
|----------------------------- | --------------- | ------------------------------------------------------------------------------ | ---------------------------------------
|
|
|
|
|Blue Square-Israel Ltd.       |                 |                                                                                | The Blue Square Chain                  
|                              |                 |                                                                                | Investments & Properties Ltd.          
|                              |                 |                                                                               
|                              |                 |                                                                                | Blue Square Real Estate Ltd.           
|                              |                 |                                                                               
|                              |                 |                                                                                | Hamachsan Hamerkazi Kfar               
|                              |                 |                                                                                | Hasha'ashuim Ltd.                      
|                              |                 |                                                                               
|                              |                 |                                                                                | Diners Club Israel Ltd.                
|                              |                 |                                                                               
|                              |                 |                                                                                |                                        
|                              |                 |                                                                                | Loyalty plan-partership                
|                              |                 |                                                                               
|The Blue Square Chain         |                 |                                                                                |                                        
|Investments & Properties Ltd. |                 |                                                                                | The Blue Square Chain (Hyper 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.                    
|                              |                 |                                                                               
|                              |                 |                                                                                |                                        
|Blue Square Real Estate Ltd.  |                 |                                                                                | Kenyon Hadar Management Company Ltd.   
|                              |                 |                                                                               
|                              |                 |                                                                                |                                        
|                              |                 |                                                                                | Joint venture Blue Square - Hadar      

F - 68

---

---

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, 2006
and 2005, 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, 2006 (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. Our 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, the consolidated financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company and its
subsidiaries at December 31, 2006 and 2005, and the consolidated results of their
operations and cash flows for each of the two years in the period ended December 31, 2006,
in conformity with Israel generally accepted accounting principles, which differ in
certain respects from those followed in the United States, as described in Note 27 to the
consolidated financial statements.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|Tel-Aviv, Israel | KOST, FORER GABBAY & KASIERER   
|March  22, 2007  | A Member of Ernst & Young Global

F - 69

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APPENDIX III

REPORT OF INDEPENDANT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of

Radio Non-Stop Ltd.

We
have audited the accompanying consolidated balance sheets of Radio Non-Stop Ltd.
(the Company) and its subsidiaries as of December 31, 2006, and the related
consolidated statements of operations, changes in shareholders equity and cash flows
for the period ended December 31, 2006 (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. Our 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, the consolidated financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company and its
subsidiaries at December 31, 2006, and the consolidated results of their operations and
cash flows for the period ended December 31, 2006, in conformity with Israel generally
accepted accounting principles, which differ in certain respects from those followed in
the United States, as described in Note 17 to the consolidated financial statements.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|Tel-Aviv, Israel | KOST, FORER GABBAY & KASIERER   
|March  20, 2007  | A Member of Ernst & Young Global

F - 70

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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 ExecutiveOfficer
| |  | ----------------------------------------------------------------------------------------------------

| |  | By: /s/ Dror Moran 
Dror Moran Vice President and Chief  FinancialOfficer
| |  | ---------------------------------------------------------------------------------------

Date: June 28, 2007



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