---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 20-F /A(AMENDMENT NO. 1)

|           |                                                                                                 
|---------- | ------------------------------------------------------------------------------------------------
|(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, 2004                                                   
|          
|OR        
|           |                                                                                                 
|o          | TRANSITION REPORT
  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934      
|           | For
  the transition period from __________ to __________                                       

Commission
file number 1-14426

|                                                        
|--------------------------------------------------------
|BLUE SQUARE-ISRAEL LTD.                                 
|                                                        
|(Exact name of Registrant as specified in its
  charter)
|                                                        
|Israel                                                  
|                                                        
|(Jurisdiction of incorporation or organization)         
|                                                        
|2 Amal Street, Rosh Haayin 48092, Israel               
|                                                        
|(Address of principal executive offices)                

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

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

|    |                                                                                              
|--- | ---------------------------------------------------------------------------------------------
|(1) | Evidenced by American Depositary Receipts.                                                   
|    |                                                                                              
|(2) | Not for trading, but only in connection with the
  listing of the American Depositary Shares.

|                                                                                              
|----------------------------------------------------------------------------------------------
|Securities
  registered or to be registered pursuant to Section 12(g) of the Act:             
|                                                                                              
|None                                                                                          
|                                                                                              
|(Title of Class)                                                                              
|                                                                                              
|Securities
  for which there is a reporting obligation pursuant to Section 15(d) of the
  Act:
|                                                                                              
|None                                                                                          
|                                                                                              
|(Title of Class)                                                                              

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

38,782,336 Ordinary Shares,
par value NIS 1.0 per share

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.

xYesoNo

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

xItem 17oItem 18

EXPLANATORY NOTE

BLUE  SQUARE-ISRAEL  LTD. (THE  COMPANY) IS FILING THIS AMENDMENT NO. 1 TO ITS ANNUAL REPORT ON FORM
20-F FOR THE YEAR ENDED DECEMBER 31, 2004 (THE 2004 20-F),  WHICH WAS  ORIGINALLY  FILED ON JUNE 30,
2005,  SOLELY TO AMEND  ITEM 15  (CONTROLS  AND  PROCEDURES)  IN  RESPONSE  TO  COMMENTS  ON ITEM 15
RECEIVED FROM THE STAFF OF THE SECURITIES AND EXCHANGE COMMISSION (THE SEC).

FOR THE  CONVENIENCE  OF THE READER,  THIS AMENDMENT NO. 1 ON FORM 20-F/A SETS FORTH THE COMPLETE TEXT
OF THE  ORIGINALLY  FILED  2004  20-F,  RATHER  THAN  JUST  THE  AMENDED  ITEM 15.  ACCORDINGLY,  THIS
AMENDMENT  NO. 1 ON FORM 20-F/A  CONTINUES TO SPEAK AS OF THE DATE OF THE ORIGINAL  FILING OF THE 2004
20-F,  AND THE  COMPANY  HAS NOT  UPDATED OR MODIFIED  THE  DISCLOSURES  CONTAINED  THEREIN TO REFLECT
SUBSEQUENT EVENTS OR DISCOVERIES.

THIS  AMENDMENT NO. 1 ON FORM 20-F/A  SHOULD BE READ IN  CONJUNCTION  WITH THE
COMPANYS  FILINGS MADE
WITH THE SEC SUBSEQUENT TO THE FILING OF THE 2004 20-F.

---

---





INTRODUCTION

Unless
otherwise indicated, as used in this annual report, (a) the term Blue
Square or the Company means Blue Square-Israel Ltd., (b) the terms
we, us and our, mean Blue Square and its consolidated subsidiaries and
(c) BSIP means Blue Square Chain Investments & Properties Ltd., a
corporation of which we held 80.7% of the outstanding shares as of March 31,
2005, and the balance of whose shares are publicly held and traded on the Tel
Aviv Stock Exchange.

We are a leading food retailer in the
State of Israel. Through our supermarkets, we offer a wide range of food and beverages
products and also Non-Food items, such as housewares, toys, electrical
appliances, computers and computer accessories, entertainment and leisure 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 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, we recently
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 we have recently started to operate several
All for a Dollar, Sheshet (housewares and small electrical
appliances) and toy departments in our stores. As of December 31, 2004, we owned and
operated 164 supermarkets under the brand names Mega, Super Center and Shefa Shuk. In
addition, due to our significant real estate holdings, we are exploring various
alternatives to maximize the potential value of our real estate assets, including our
unused building rights. For further information regarding our real estate, see Item
4. Information on The Company  B. Business Overview  Real Estate. We
were incorporated in June 1988. In 1996, we completed our initial public offering and
our American Depositary Shares, or ADSs, were listed for trading on the New York Stock
Exchange. In November 2000, our ordinary shares were listed for trading on the Tel
Aviv Stock Exchange.

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

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

All
references in this annual report to dollars or $ are to U.S. dollars and all
references in this annual report to NIS are to New Israeli Shekels. Unless
mentioned otherwise, all figures in U.S. dollars are based on the
representative exchange rate between the NIS and the dollar as published by the
Bank of Israel for December 31, 2004, which was NIS 4.308 per $1.00,
except figures for the first quarter of 2005, which are based on the representative
exchange rate between the NIS and the dollar as published by the Bank of Israel
for March 31, 2005, which was NIS 4.361 per $1.00.

---

---



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

NOTE REGARDING TRANSITION TO
NOMINAL-HISTORICAL
FINANCIAL REPORTING

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

(i)   Through
December 31, 2003, in accordance with pronouncements of the Israel Accounting
Standards Board, the Company prepared its financial statements on the basis of
historical cost adjusted for the changes in the general purchasing power of the
NIS, based upon changes in the consumer price index (the CPI). The adjusted
amounts, as above, presented in the financial statements as of December 31,
2003, are used as the opening balances for the nominal-historical financial
reporting in the following periods. Additions made after December 31, 2003 have
been included in the financial statements at their nominal values.

(ii)  The
comparative figures included in our financial statements through December 31,
2003 are based on the adjusted financial statements for the prior reporting
periods, as previously presented, after adjustment to the CPI in effect at
December 31, 2003.

(iii) The
amounts reported for periods after December 31, 2003 are composed as follows:
all the amounts originating from the period prior to December 31, 2003 are
composed of their adjusted amount at December 31, 2003, with the addition of
amounts in nominal values that were added after December 31, 2003, and net of
amounts that were deducted after December 31, 2003 (and deductions from such
sums are effected at their adjusted values as of December 31, 2003, their
nominal values, or a combination of the two, according to the
circumstances). All the amounts originating
from the period after December 31, 2003 are included in the financial
statements at their nominal values.

---

---



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                                                     | 13  
|         | ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND
  PROSPECTS                                 | 31  
|         | ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                     | 52  
|         | ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY
  TRANSACTIONS                            | 73  
|         | ITEM 8.   | FINANCIAL INFORMATION                                                          | 79  
|         | ITEM 9.   | THE OFFER AND LISTING                                                          | 82  
|         | ITEM 10.  | ADDITIONAL INFORMATION                                                         | 85  
|         | ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES
  ABOUT MARKET RISK                   | 109 
|         | ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY
  SECURITIES                       | 110 
|         |           |                                                                                |     
|PART II  | 111      
|        
|         | ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND
  DELINQUENCIES                              | 111 
|         | ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF
  SECURITY HOLDERS AND USE OF PROCEEDS | 111 
|         | ITEM 15.  | CONTROLS AND PROCEDURES                                                        | 111 
|         | ITEM 16.  | [RESERVED]                                                                     | 111 
|         | ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                               | 111 
|         | ITEM 16B. | CODE OF ETHICS                                                                 | 111 
|         | ITEM 16C. | ACCOUNTANTS FEES AND SERVICES                                                  | 112 
|         | ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR
  AUDIT COMMITTEES                   | 113 
|         | ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE
  ISSUER AND AFFILIATED PURCHASERS       | 113 
|         |           |                                                                                |     
|PART III | 114      
|        
|         | ITEM 17.  | FINANCIAL STATEMENTS                                                           | 114 
|         | ITEM 18.  | FINANCIAL STATEMENTS                                                           | 114 
|         | ITEM 19.  | EXHIBITS                                                                       | 114 

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, 2003 and 2004 and for each of the years ended
December 31, 2002, 2003 and 2004 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, 2000, 2001, and 2002 and for each of the
years ended December 31, 2000, and 2001 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 - 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

---

---



|                                                                       |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|---------------------------------------------------------------------- |  | --------------------------------------------------------------- | --------- | ---- |  | --------- | - | ---- | --------- | ---- |  | --------- | - |  | --------- | - |  | --------- | -
|                                                                       |  | 2000                                                            |           | 2001 |  | 2002      |   | 2003 |           | 2004 |  | 2004      |  
|                                                                       |  |                                                                 |           |      |  |           |   |      |           |      |  |           |  
|                                                                       |  | NIS (In
  thousands, except per ordinary share or ADS data) (1) |           | $(2) | 
|                                                                       |  |                                                                 |           |      | 
|                                                                       |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|Income Data                                                            |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|Sales                                                                  |  |                                                                 | 5,508,946 |      |  | 5,828,391 |   |      | 5,444,306 |      |  | 5,170,510 |   |  | 5,365,784 |   |  | 1,245,539 |  
|                                                                      
|Cost of sales                                                          |  |                                                                 | 3,976,589 |      |  | 4,215,439 |   |      | 3,974,628 |      |  | 3,777,411 |   |  | 3,962,303 |   |  | 919,755   |  
|                                                                      
|Gross profit                                                           |  |                                                                 | 1,532,357 |      |  | 1,612,952 |   |      | 1,469,678 |      |  | 1,393,099 |   |  | 1,403,481 |   |  | 325,784   |  
|Selling, general and administrative
  expenses                         |  |                                                                 | 1,244,934 |      |  | 1,296,217 |   |      | 1,250,662 |      |  | 1,190,425 |   |  | 1,203,391 |   |  | 279,339   |  
|                                                                      
|Operating income                                                       |  |                                                                 | 287,423   |      |  | 316,735   |   |      | 219,016   |      |  | 202,674   |   |  | 200,090   |   |  | 46,445    |  
|                                                                      
|Financial income (expenses), net                                       |  |                                                                 | (44,227   | )    |  | (13,109   | ) |      | 15,900    |      |  | (48,813   | ) |  | (58,090   | ) |  | (13,484   | )
|                                                                      
|Amortization of goodwill                                               |  |                                                                 | (5,953    | )    |  | (5,277    | ) |      | (5,277    | )    |  | (5,740    | ) |  | (5,870    | ) |  | (1,362    | )
|                                                                      
|Other income (expenses), net                                           |  |                                                                 | 20,280    |      |  | (18,152   | ) |      | (174,004  | )    |  | (136,612  | ) |  | (19,593   | ) |  | (4,548    | )
|                                                                      
|Taxes on income                                                        |  |                                                                 | 95,872    |      |  | 107,823   |   |      | 42,078    |      |  | 8,445     |   |  | 41,230    |   |  | 9,571     |  
|                                                                      
|Equity in net earnings (loss) of affiliates                            |  |                                                                 | 1,383     |      |  | 3,561     |   |      | (363      | )    |  | 742       |   |  | (1,204    | ) |  | (279      | )
|                                                                      
|Minority interest                                                      |  |                                                                 | 23,305    |      |  | 25,123    |   |      | 5,953     |      |  | 10,852    |   |  | 13,555    |   |  | 3,146     |  
|                                                                      
|Loss from discontinued operation                                       |  |                                                                 | 2,649     |      |  | -         |   |      | -         |      |  | -         |   |  | -         |   |  | -         |  
|                                                                      
|Net income (loss)                                                      |  |                                                                 | 137,081   |      |  | 150,812   |   |      | 7,241     |      |  | (7,046    | ) |  | 60,548    |   |  | 14,055    |  
|Earnings (loss) per ordinary share or ADS
  from continuing Operations |  |                                                                 | 3. 64     |      |  | 3.93      |   |      | 0.19      |      |  | (0.18     | ) |  | 1,57      |   |  | 0.36      |  
|Losses per ordinary share or ADS from
  discontinued Operations        |  |                                                                 | (0.07     | )    |  | -         |   |      | -         |      |  | -         |   |  | -         |   |  | -         |  
|Total Earnings (loss) per ordinary share or
  ADS                      |  |                                                                 | 3.57      |      |  | 3.93      |   |      | 0.19      |      |  | (0.18     | ) |  | 1.57      |   |  | 0.36      |  
|Cash dividends per ordinary share or ADS                               |  |                                                                 | 1.08      |      |  | 1.35      |   |      | 3.33      |      |  | 7.68      |   |  | 6.38      |   |  | 1.48      |  
|U.S. GAAP:                                                             |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|                                                                       |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|Net income (loss)                                                      |  |                                                                 | 133,787   |      |  | 151,393   |   |      | 62,596    |      |  | (952      | ) |  | 45,235    |   |  | 10,500    |  
|                                                                      
|Earnings (loss) per ordinary share or ADS
  from continuing operation  |  |                                                                 | 3.65      |      |  | 3.94      |   |      | 1.63      |      |  | (0.02     | ) |  | 1.17      |   |  | 0.27      |  
|Losses per ordinary share or ADS from
  discontinued operations        |  |                                                                 | (0.17     | )    |  | -         |   |      | -         |      |  | -         |   |  | -         |   |  | -         |  
|Total Earnings (loss) per ordinary share or
  ADS                      |  |                                                                 | 3.48      |      |  | 3.94      |   |      | 1.63      |      |  | (0.02     | ) |  | 1.17      |   |  | 0.27      |  
|                                                                       |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|Selected Operating Data:                                               |  |                                                                 |           |      |  |           |   |      |           |      |  |           |   |  |           |   |  |           |  
|Number of stores (at year end)                                         |  |                                                                 | 168       |      |  | 171       |   |      | 173       |      |  | 161       |   |  | 164       |   |  | N/A       |  
|                                                                      
|Decrease in same store sales                                           |  |                                                                 | 4.4       | %    |  | 3.2       | % |      | 11.2      | %    |  | 11.2      | % |  | 0.6       | % |  | N/A       |  
|                                                                      
|Total square meters (at year end)                                      |  |                                                                 | 258,000   |      |  | 279,000   |   |      | 292,600   |      |  | 290,800   |   |  | 300,000   |   |  | N/A       |  
|                                                                      
|Sales per square meter (in NIS)(3)                                     |  |                                                                 | 22,095    |      |  | 22,017    |   |      | 19,229    |      |  | 17,906    |   |  | 18,074    |   |  | 4,195     |  
|                                                                      
|Sales per employee (in thousands)                                      |  |                                                                 | 743       |      |  | 743       |   |      | 732       |      |  | 758       |   |  | 804       |   |  | 187       |  



---

|    |                                                                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For
  the years 2000-2003, 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, 2004 (NIS 4.308 =$1.00), as published by the Bank of Israel.
|    |                                                                                                                                                                                                                                  
|(3) | Based
  on an average total square meters at month end during the relevant year.                                                                                                                                                 

2

---

---



|                                        |  |                          |           |      |      |           |   |      |           |      |  |           |   |  |           |   |  |         |  
|--------------------------------------- |  | ------------------------ | --------- | ---- | ---- | --------- | - | ---- | --------- | ---- |  | --------- | - |  | --------- | - |  | ------- | -
|                                        |  | December 31,             |          
|                                        |  |                          |          
|                                        |  | 2000                     |           | 2001 |      | 2002      |   | 2003 |           | 2004 |  | 2004      |  
|                                        |  |                          |           |      |      |           |   |      |           |      |  |           |  
|                                        |  | NIS (in
  thousands) (1) |           |      | $(2) |          
|                                        |  |                          |           |      |      |          
|Balance
  Sheet Data:                   |  |                          |           |      |      |           |   |      |           |      |  |           |   |  |           |   |  |         |  
|Israeli GAAP:                           |  |                          |           |      |      |           |   |      |           |      |  |           |   |  |           |   |  |         |  
|Working capital deficit                 |  |                          | (384,014  | )    |      | (263,243  | ) |      | (388,177  | )    |  | (288,831  | ) |  | (380,666  | ) |  | (88,363 | )
|Total assets                            |  |                          | 3,213,967 |      |      | 3,347,161 |   |      | 3,232,733 |      |  | 3,199,680 |   |  | 3,079,011 |   |  | 714,719 |  
|Short-term credit from banks and
others |  |                          | 347,688   |      |      | 235,597   |   |      | 318,424   |      |  | 212,521   |   |  | 136,541   |   |  | 31,695  |  
|Long-term debt                          |  |                          | 329,254   |      |      | 395,747   |   |      | 355,320   |      |  | 686,084   |   |  | 776,568   |   |  | 180,262 |  
|Shareholders equity                    |  |                          | 1,354,444 |      |      | 1,459,714 |   |      | 1,339,416 |      |  | 1,037,340 |   |  | 819,310   |   |  | 190,184 |  
|U.S. GAAP:                              |  |                          |           |      |      |           |   |      |           |      |  |           |   |  |           |   |  |         |  
|Total assets                            |  |                          | 3,215,305 |      |      | 3,358,897 |   |      | 3,271,342 |      |  | 3,262,934 |   |  | 3,147,284 |   |  | 730,567 |  
|Shareholders equity                    |  |                          | 1,330,461 |      |      | 1,440,506 |   |      | 1,375,566 |      |  | 1,082,450 |   |  | 873,120   |   |  | 202,674 |  

|    |                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For
  the years 2000-2003, 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, 2004 (NIS 4.308 = $1.00), as published by the Bank of
  Israel.

B.        Capitalization
and Indebtedness.

Not
applicable.

C.        Reasons
for the Offer and Use of Proceeds.

Not
applicable.

D.        Risk
Factors.

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

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

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

3

---

---



In
recent years, due to a recession and an increase in unemployment in Israel, the
most important factor in the purchase decisions of a larger portion of the
Israeli public has been the price of the products it purchases.  Even following the economic recovery in
2004, price has remained a significant factor in the purchase decisions of many
consumers.  As a result, we and other
major chains have continued our expansion into low-priced store formats and,
during 2005, other major chains have expanded into hard discount formats.  In addition, in response to the increased
focus on the price of products, private supermarkets have continued to expand
their presence in selected areas, increasing competition in an already
difficult market. 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. As a result, in 2004, these private supermarkets continue to
increase their market share.

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.

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.

4

---

---



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 2004, Tnuvas products
accounted for approximately 12.1% of
all the products sold at our supermarkets. In addition, Elite, which merged in
2003 with Strauss, an Israeli food manufacturer, accounted in 2004 for
approximately 9.8% of all products sold at our supermarkets, and the Osem group
accounted for approximately 7.6% of all products sold at our supermarkets in
2004. 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, Elite and Osem, we do not believe that
there is a material risk of future stoppage of supply of products of these key
suppliers. However, we do not have a written contract with Tnuva, Elite or Osem
obligating them to supply products to us. The ten largest suppliers accounted
for approximately 48% of our products purchases in 2004. We cannot assure you
that, in the future, Tnuva, Elite, 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.

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

Bronfman-Alon
Ltd. (Bronfman-Alon) currently owns approximately 77.38% of Blue Squares
ordinary shares following the conversion by other investors of an aggregate of
approximately NIS 13.8 million in principal amount of our 5.9% convertible
debentures since their issuance in August 2003.  So long as Bronfman-Alon, or any successor to its shareholdings
in Blue Square, continues to own beneficially more than 50% of our outstanding
ordinary shares and voting power, it will be able to control the outcome of
matters requiring shareholder approval, including the election of all Blue
Square directors, other than Blue Square two external directors whose election,
under the Israeli Companies Law, requires that at least one-third of the non-controlling
shareholders who participate in the vote, vote for their nomination, or that
the total number of shares of non-controlling shareholders voted against their
nomination does not exceed one percent of the aggregate voting rights in the
company.

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

5

---

---



We
directly operate all of the supermarkets that Blue Square owns directly and
those that are owned by BSIPs subsidiaries. As of December 31, 2004, Blue
Square owned directly 104 supermarkets; the balance of our operations were
owned by BSIPs subsidiaries, each of which has its own board of directors and
management. These subsidiaries include BSIP, in which Blue Square owns an 80.7%
interest, and the Blue Square Chain (Hyper Hyper) Ltd., or Hyper Hyper, in
which BSIP owns a 100% interest and, therefore, Blue Square indirectly owns an
80.7% interest. The ordinary shares of BSIP that are not owned by Blue Square
are publicly held and traded on the Tel Aviv Stock Exchange. The consolidated
sales of BSIP and its subsidiaries in 2004 aggregated approximately NIS 3,625 million,
or $842 million, representing approximately 68% of our consolidated sales for
2004. At December 31, 2004, the total consolidated assets of BSIP and its
subsidiaries aggregated approximately NIS 1.2 billion, or $285 million,
constituting approximately 39.9% of our total consolidated assets at December
31, 2004.

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

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 may prescribe extensive investment in safety
equipment, the retaining of security personnel and may lengthen the time
dedicated for obtaining permits from the municipal authorities. If we are
unable to obtain or maintain one or more required permits, we may be required
to close one or more stores or to take other remedial action to obtain or
maintain these permits.

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

A
substantial portion of our employees wages is adjusted upon a change in the
minimum wage in Israel. Under Israeli law, minimum wage equals 47.5% of the
average wage for an employee in Israel. The minimum monthly wage since January
2003 has been NIS 3,335, or $774.  An
increase in minimum wage will increase our labor costs and thus adversely
affect our operating results.

6

---

---



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

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

|  |                                                                                                     
|- | ----------------------------------------------------------------------------------------------------
| | actual or
  anticipated variations in our quarterly operating results or those of our
  competitors;
|  |                                                                                                     
| | changes in
  financial estimates by securities analysts;                                            
|  |                                                                                                     
| | conditions
  or trends in our business;                                                             
|  |                                                                                                     
| | changes in
  the market valuations of our competitors;                                              
|  |                                                                                                     
| | announcements
  by us or our competitors of significant acquisitions;                               
|  |                                                                                                     
| | entry into
  strategic partnerships or joint ventures by us or our competitors;                     
|  |                                                                                                     
| | the
  political, economic, security and military conditions in Israel;                              
|  |                                                                                                     
| | additions or
  departures of key personnel;                                                         
|  |                                                                                                     
| | sales of
  ordinary shares by Blue Squares controlling shareholder; and                            
|  |                                                                                                     
| | disputes
  between our controlling shareholders.                                                    

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

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

Restrictions on the payment of dividends may
limit our ability to pay cash dividends on our ordinary shares.

In
connection with our issuance of NIS 400 million in aggregate principal amount
of unsecured 5.9% convertible and nonconvertible debentures in August 2003,
Blue Squares Board of Directors resolved that Blue Square would not distribute
dividends in any quarter if the ratio of our financial obligations (as defined
by Maalot, an Israeli rating agency, and affiliate of S&P) (Maalot) to
EBITDA for any quarter exceeds 3.5 until June 30, 2006 or exceeds 3.0
thereafter.  Blue Squares Board also
resolved that Blue Square would not distribute dividends in any quarter if the
ratio of the cost of unencumbered fixed assets as set forth on our financial
statements (following depreciation) to financial obligations (as defined by
Maalot) for any quarter is below 120%. Maalot has informed us that a change in
this Board resolution may lead to a downgrading of the rating on our 5.9%
unsecured debentures.  Following the
dividends distributions of 2003 and 2004 the retain earnings of Blue Square
decreased significantly. As a result of this Board resolution and the other
restrictions, we may not be able to pay cash dividends on our ordinary shares
in the same amount as in 2003 and 2004, and you may not be able to receive
adequate return on your shares through the payment of dividends.

7

---

---



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

Out
of the NIS 400 million in aggregate principal amount of unsecured 5.9%
debentures that we issued in August 2003, NIS 200 million in aggregate
principal amount were convertible debentures (principal repayable in three
equal installments in the years 2007, 2009 and 2011) which are currently
convertible into Blue Square ordinary shares at per share price of NIS 34.2.
This conversion ratio is subject to adjustment in the event of distribution of
bonus shares, cash dividends and the issuances of rights. On June 15, 2005, the
closing price per share of our ordinary shares on the Tel Aviv Stock Exchange
was NIS 40.24.

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.
The Commissioner of the Israeli Antitrust Authority may limit 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 contains his view of the
legality of certain commercial conduct between the large supermarket chains (which
consists of Super Sol, ClubMarket and us) and the large suppliers, which was
exposed during the investigation.

8

---

---



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

|  |                                                                                                                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The legal
  department of the Israeli Antitrust Authority is to take appropriate legal
  proceedings against any party to a clear violation of the law exposed during
  the investigation and, if necessary, take prospective legal measures, such as
  injunctions and issuing directives to monopolists.
|  |                                                                                                                                                                                                                                                                                                           
| | Demand from
  the relevant supermarket retail chains and food suppliers to provide all existing agreements and arrangements with regard to year
2004 in order to ensure that the
  illegal practices have ceased and that the recommendations of the
  Commissioner have been implemented.                
|  |                                                                                                                                                                                                                                                                                                           
| | To review
  the practices and customs between the dominant
  suppliers and other supermarkets (i.e., which are not among the major
  supermarket retail chains) in order to confirm the legality of these
  arrangements under the antitrust laws.                                                        

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

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

Following
a meeting with the Commissioner, 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 have begun negotiations with the
Commissioner with respect to the contents of the consent decree. 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.

We
understand from recent press reports that the Commissioner has delivered to the
large suppliers a draft of a proposed consent decree. We have not received
confirmation that this has occurred, nor do we have any knowledge regarding the
content of such consent decree or the response of the large suppliers to any
such consent decree.

9

---

---



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.

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

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

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

We
have one distribution center in Rishon Letzion from which we distribute to our
supermarkets a large portion of the products they carry. The products
distributed by our distribution center generated approximately 23% of our total
percentage sales during 2004.  Our
inability to utilize the distribution center for any reason may significantly
impair our ability to distribute our products to our supermarkets and would
adversely affect our profit margin.

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

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

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 may be
considered part of one borrowing group with our controlling shareholders
and/or, under certain circumstances, with interested parties in the group,
including Bronfman-Alon Ltd., Dor Alon group, Africa Israel group (an
interested party in Dor Alon) and corporations under their control.  Blue Square and its subsidiaries may face
limitations from time to time in their ability to obtain additional credit from
Israeli banks due to these Bank of Israel regulations, which would adversely
affect our ability to operate our business as we have in the past.

10

---

---



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.

A new published
Israeli Accounting Standard could have an adverse effect on our results of
operations.

In
accordance with Israeli Accounting Standards No. 12 and No. 17 adopted by the
Israeli Accounting Standards Board, our financial statements ceased to be
adjusted for inflation in Israel for periods beginning on or after January 1,
2004. The amounts included in our financial statements as of December 31, 2003
served as the starting point for nominal financial reporting beginning January
1, 2004. The adoption of Standard No. 12 could have material adverse effect on
our results of operations. As a result of the adoption of these standards, our
assets and shareholders equity ceased to be adjusted for inflation in Israel,
while the repayment of interest and principal under most of our loans and all
debentures continues to be linked to the Israeli CPI, as provided in our loan
and debenture agreements. As a result, an increase in inflation would have the
effect of increasing our financial expenses without any offsetting increase in
our assets and revenues on our financial statements, leading to lower reported
earnings and shareholders equity. The extent of this effect on our financial
statement would be dependent on the rate of inflation in Israel.

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.

11

---

---



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, although recently hostilities have somewhat
decreased. These hostilities include terrorist acts in Israel and military
operations in the West Bank and Gaza.

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 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 the years 2001 and 2002, Israels Gross Domestic Product
declined by 0.9% and 0.7%, respectively, while in 2003 and 2004, it rose by
1.3% and 4.3%, respectively. The economic slowdown during 2001, 2002 and a
portion of 2003 years adversely affected our financial performance.  Initial reports indicate that the Israeli
economy will grow by approximately 4.0% in 2005. We cannot be sure how any
growth or decline in the Israeli economy will affect our financial
performance.

12

---

---



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

The
Israeli government is authorized to control the prices of goods and services
offered in Israel.  At present, some of
the products we offer in our stores, including bread, flour, eggs, milk and
margarine are subject to government-imposed price controls.  In addition, during periods of high
inflation in the past, more extensive price controls have been imposed
throughout Israel.  We do not believe
that current price controls have any
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 all of 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.

|        |                           
|------- | --------------------------
|ITEM 4. | INFORMATION ON THE COMPANY

A.       History
and Development of Blue Square.

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

Effective
January 1, 1996, we and our former controlling shareholder, the Co-Op,
completed a reorganization of holdings, pursuant to which the Co-Op transferred
to Blue Square in consideration for 29,789,000 of Blue Squares ordinary
shares, its then 67% interest in BSIP and other shareholdings and rights. In
1996, Blue Square completed its initial public offering and its ADSs were
listed for trading on the New York Stock Exchange.  In November 2000, Blue Squares ordinary shares were listed
for trading on the Tel Aviv Stock Exchange.

In
June 2003, Bronfman  Alon acquired 78.1% of the outstanding shares of Blue
Square from the Co-Op.  See - Change in
Control below.  Bronfman-Alon currently
owns approximately 77.38% of the outstanding shares following to the conversion
by other investors of an aggregate of approximately NIS 13.8 million in
principal amount of our 5.9% convertible debentures since their issuance in
August 2003.

The
following significant events have occurred during the last two years:

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The issuance
  in 2003 of NIS 400 million in aggregate principal amount of unsecured 5.9%
  debentures (with final maturity dates of either 2011 or 2014), half of which
  are convertible into Blue Square ordinary shares. As of June 15, 2005, the
  per share conversion price of the convertible debentures was NIS 34.2 and is
  subject to adjustment for cash dividends that may distributed from time to time. The
  debentures were rated AA by Maalot (an Israeli rating agency) so long as
  the limitations on the distribution of dividends are in accordance with the
  decisions of the Board of Directors (see Item 3. Key Information - D. Risk
  Factors.  Restrictions on the payment
  of dividends may limit our ability to pay cash dividends on our ordinary
  shares);

13

---

---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The payment
  of dividends from June 2003 to May 2005 totaling approximately $136.2
  million, equal to approximately $3.43 per share (see Item 3. Key Information
  - D. Risk Factors.  Restrictions on
  the payment of dividends may limit our ability to pay cash dividends on our
  ordinary shares);                                                                                                                                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | The
  implementation of an efficiency plan, including the dismissal of employees,
  replacement of maintenance and security contractors via new tenders,
  outsourcing some of our activities, and closing underperforming stores
  (stores with negative cash flow);                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | The
  consolidation of our store brands to just three, which enables us to focus
  our marketing efforts more effectively and differentiate our store brands;
  and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | The increase
  of the variety of Non-Food and Near-Food items, which have higher average
  margins, with the goal of increasing the portion of our customers overall
  shopping needs that are addressed in our stores.  As part of this strategy, we recently acquired 50% of the
  holdings of Hamachsan Hamerkazi Kfar Hashaashuim Ltd. (Central
  Warehouse/Toy Village), Israels largest franchiser of All for a Dollar,
  toy and houseware stores. In addition, we have applied for licenses to sell
  over the counter pharmaceutical medical products (OTC drugs) to further
  expand the mix of goods sold in our stores.
  Some of our license applications have already been approved.

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, 2005, we invested NIS 11.7 million, or $2.7
million in fixed and other assets.  In
2004, we invested NIS 89.4 million, or $20.8 million in fixed and other
assets, a 35.5% decrease from our 2003 investment of
NIS 138.7 million, or $32.2 million. This decrease is primarily
attributable to our continued strategy of leasing store sites with an option to
renew the lease, rather than to purchase store sites and our opening of fewer
stores than in 2003. Of our fixed asset investment in 2004, we invested
NIS 13.3 million, or $3.1 million in land and buildings, including land
that we lease, as compared with NIS 27.2 million, or $6.3 million in
2003.  In 2002, we invested
NIS 243.2 million, or $56.5 million in fixed and other assets.  As of December 31, 2004, we had entered
into agreements for investments in fixtures and equipment in an aggregate of
NIS 12 million, or $2.8 million.

14

---

---



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.

Change in Control

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

During the
years 2004 and 2005, each of our two indirect controlling shareholder groups
(the Dor-Alon group and the Bronfman-Fisher group, each of which owns a 50%
interest in Bronfman-Alon) offered to acquire the 50% interest in Bronfman-Alon
held by the other group.  Each group
rejected the offer from the other group and continues to hold its respective
50% interest in Bronfman-Alon.

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

B.        Business
Overview.

General

We
are a leading food retailer in the State of Israel.  Through our supermarkets, we offer a wide range of food and
beverages products and also Non-Food items, such as housewares, toys,
electrical appliances, computers and computer accessories, entertainment and
leisure products, and Near-Food products, such as health and beauty aids,
infants products, cosmetics and hygiene products and prescription drugs, and
recently started to operate several All for a Dollar departments in our
stores.  As of December 31, 2004,
we owned and operated 164 supermarkets under the brand names Mega, Super Center
and Shefa Shuk. Our activities are carried out via Blue Square and its
consolidated subsidiaries, the largest of which is BSIP.  As of March 31, 2005, Blue Square owned
80.7% of the outstanding shares of BSIP, the balance of which were publicly
held and traded on the Tel Aviv Stock Exchange.  BSIP and its direct and indirect subsidiaries, including Blue
Square Chain (Hyper Hyper) Ltd., are the owners of 60 of our supermarkets.  The consolidated sales of BSIP and its
subsidiaries in 2004 aggregated approximately 68% of our consolidated sales for
that period.  As of March 31, 2005,
the total consolidated assets of BSIP and its subsidiaries aggregated
approximately NIS 1.2 billion, or $286 million, constituting approximately
38.9% of our total consolidated assets at that date.

15

---

---



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, 2000 |  |  | 168           |  |                               | 258,000 | 
| | As
  of December 31, 2001 |  |  | 171           |  |                               | 279,000 | 
| | As
  of December 31, 2002 |  |  | 173           |  |                               | 292,600 | 
| | As
  of December 31, 2003 |  |  | 161           |  |                               | 290,800 | 
| | As
  of December 31, 2004 |  |  | 164           |  |                               | 300,000 | 

During
the past year, we completed the process of streamlining our store brands to
just three  Mega, Super Center and Shefa Shuk. In the Mega chain stores,
which are located primarily outside the city centers, we offer the widest
selection of food, Near-Food and Non-Food items at reduced prices.  In the Super Center
chain stores, which
are usually smaller than Mega stores and are located primarily in local
neighborhoods and city centers, we offer a more limited selection of food,
Near-Food and Non-Food items at competitive prices.  Our Shefa Shuk chain stores are low
priced
stores with a selection of products specially oriented towards Israels growing
ultra-orthodox population and also designated to compete with local
competition. As of December 31, 2004, we operated 37 Mega Stores, consisting of
approximately 156,000 square meters space, 101 Super Center stores, consisting
of approximately 101,000 square meters space, and 26 Shefa Shuk stores,
consisting of approximately 43,000 square meters space.

We
operate a Buy & Bonus frequent-buyer incentive program and a Mega
frequent-buyer incentive program, which are designated to increase consumer
traffic and encourage customers to patronize our stores and to allow our
customers to earn free gifts by earning points. These customer clubs grant a
variety of discounts and benefits to participants. The benefits are published
each month in a Buy & Bonus magazine which is distributed in our stores
and in the general media.  We are
currently considering to expand and improve these customer clubs and, alternatively,
to merge these customer clubs and to consolidate them with third party club(s)
in order to enhance their attractiveness.
A final decision has not yet been reached.

Industry Overview

We
estimate that retail sales of food, beverages and tobacco in Israel was
approximately NIS 40 to 41 billion, or $9.3 to $9.5 billion, in 2004.  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 2003 (2004 has not yet been published) and the growth
of expenditure for the consumption of food, beverages and tobacco of household
in Israel in 2004 (2.95%).

16

---

---



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 three large
chains: Super Sol, ClubMarket 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.  We estimate that approximately
36% of the total retail sales of food, beverages and tobacco in Israel in 2004
was made by the three large chains and 50% was made by all chains  - a percentage that is considerably lower
than the estimated market shares prevailing in Europe and the United
States.  Accordingly, we believe that
there is an opportunity for us to grow correspondingly with the general growth
of the supermarket sector in Israel.

Our Supermarkets

We
operate three supermarket formats, tailoring store sizes and product ranges to
meet the preferences of each formats target customers. Our supermarket formats
are among the most recognized in Israel. According to A.C. Nielsen, our market
share of the bar-coded market of non-durable goods in 2004 was 25.1%.

See
Our Operations for a description of our supermarket formats as of December
31, 2004.

Seasonality

Our
business is subject to fluctuations in quarterly sales and profits.  These fluctuations are primarily
attributable to increased sales and higher operating income in the holiday
seasons occurring in different quarters from year to year.  Thus, for example, increased sales
attributable to Passover, which occurs in either March or April, may be
realized in either the first or the second quarter, and sales attributable to
the Jewish New Year, which occurs in either September or October, may be
realized in our financial report in either the third or the fourth
quarter.  Generally, purchases for a
particular holiday occur during the two-week period prior to the commencement
of that holiday.  However, the timing of
the holidays does not affect our semiannual results.

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

Our Strategy

Our
strategy is to take advantage of our position as a leading food retailer in
Israel, by expanding our market presence in existing retail food markets and by
entering into new retail food, Near-Food and Non-Food markets.  To achieve this goal, we intend to
pursue a
number of operating and growth strategies, which include:

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

17

---

---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 electrical appliances,
  computers and computer accessories.
  As part of this strategy, we recently acquired 50% of the holdings of
  Hamachsan Hamerkazi Kfar Hashaashuim Ltd. (Central Warehouse/Toy Village),
  Israels largest franchiser of All for a Dollar, toy and houseware stores;
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | considering the possibility of offering and selling other products,
  such as financial instruments and insurance, to our consumers;                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | exploring various alternatives to maximize the potential value of our
  real estate assets, including unused building rights;                                                                                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | differentiating our store brands and products from those of our
  competitors;                                                                                                                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | increasing operational efficiency;                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | synergies with our affiliated entities, such as our procurement
  agreement with Dor Alon Operating Service Stations Ltd., in which we agreed
  to procure products for their convenience stores;                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | focusing on improving the availability of products in our stores and
  reducing the shortage of products on the shelves;                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | expanding and improving our customer clubs and, alternatively,
  merging these customer clubs and consolidating them with third party club(s)
  in order to enhance their attractiveness; and                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | examining the feasibility of establishing and operating gasoline stations near our Mega stores.                                                                                                                                                                                                                                                                                                                                                                  

Real Estate

Most of our
acquisitions of real estate have been in connection with the retail operation
of our stores.  Nevertheless, through
our Real Estate Development Division, we are exploring various alternatives to
maximize the potential value of our real estate assets, including our unused building
rights.  Among the alternatives, we will
consider methods to raise capital through our real estate assets (such as an
offering to the public, securitizations of cash flow, and sale and re-leasing
of real estate on terms more beneficial to us) and/or transfer of real estate
to a subsidiary and/or accepting third party investors in our real estate.

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 other supermarket chains, such as Super Sol and
ClubMarket, low-priced private supermarkets, independent grocers, open-air
markets, and other retailers selling supermarket goods. Competitive pressures
increase as the supermarket sector in Israel approaches higher saturation
levels and will continue to increase in the event that our competitors expand
their operations or new companies enter the market with hard discount
formats.

18

---

---



We
and other major chains have expanded into low-priced store formats and, during
2005, other major chains have expanded into hard discount formats. In addition,
private supermarkets have continued to expand in selected areas. 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.
As a result, in 2003-2004 these private supermarkets increased their
market share.

In the sale
of cosmetic, toiletries and hygiene products, we compete against establishments
that sell such products, including the drug store chains SuperPharm and
NewPharm.

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

Our Operations

Our
supermarket operations are conducted under the Mega, Super Center and Shefa
Shuk store formats, which are among the most well-recognized retail names in
Israel. Our supermarkets offer a wide selection of supermarket goods.  The mix of products of each supermarket
format varies to address the preferences of its target customers.  Many of our supermarkets offer specialty
departments such as full service bakeries, delicatessens, fresh meat and
prepared food departments; certain supermarkets also contain franchise
operations, which sell a variety of goods.
Fifteen of our supermarkets also include drugstores, which sell
medications, prescription medicines, cosmetics, perfume and personal hygiene
items. In addition, we offer a range of Non-Food and Near-Food items and
recently started to operate several All for a Dollar departments in our
stores. Furthermore, we have applied for licenses to sell over the counter
pharmaceutical medical products. Some of our license applications have already been approved.

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

19

---

---



The
following table provides certain information regarding the Blue Square stores
and the BSIP stores as of December 31, 2004:

|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|--------------- |  | ------------------ | ------------------ | ---- |  | ------------------------------ |  |  | ------------------- |  |  | ------------------------------ |  |  | ------------------- |  |  | ------------------------------ | 
|                |  | Blue Square Israel |                    | BSIP |  | TOTAL                          | 
|                |  |                    |                    |      |  |                                | 
|               
|Retail Format   |  |                    | Number
  of Stores |      |  | Store Space 
  (square meters) |  |  | Number of 
  Stores |  |  | Store Space 
  (square meters) |  |  | Number of 
  Stores |  |  | Store Space 
  (square meters) | 
|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|Mega(1)         |  |                    | 1                  |      |  | 7,000                          |  |  | 36                  |  |  | 149,000                        |  |  | 37                  |  |  | 156,000                        | 
|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|Super Center(2) |  |                    | 90                 |      |  | 83,000                         |  |  | 11                  |  |  | 18,000                         |  |  | 101                 |  |  | 101,000                        | 
|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|Shefa  Shuk(3)  |  |                    | 13                 |      |  | 15,600                         |  |  | 13                  |  |  | 27,400                         |  |  | 26                  |  |  | 43,000                         | 
|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|                |  |                    |                    |      |  |                                |  |  |                     |  |  |                                |  |  |                     |  |  |                                | 
|Total           |  |                    | 104                |      |  | 105,600                        |  |  | 60                  |  |  | 194,400                        |  |  | 164                 |  |  | 300,000                        | 

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

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

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

Purchasing and Distribution

We
purchase products for our supermarkets through a central purchasing office that
selects products for all of our supermarkets and negotiates prices, promotions
and terms of payment with individual suppliers on a company-wide basis.  We believe that our large volume of
purchases and our ability to offer chain-wide exposure for our suppliers
products and promotions, enable us to avail ourselves of attractive
volume-buying opportunities and manufacturers discounts.

Through
our distribution center, we can distribute products from suppliers, manufacturers
and importers, thus reducing prices and broadening the range of available
products.  The distribution center is
operated on a 40,000 square meter site.
At this site, we operate approximately 20,000 square meters as warehouse
space.  We conduct the administration of
the warehouses and distribution by means of a computerized system that
consolidates orders from all the branches while giving consideration to
inventory levels, store requests and company planning.

20

---

---



We
purchase products for our supermarkets from more than 1,100 suppliers,
including manufacturers, importers and distributors.  Approximately 83% of our grocery items and 86% of our meat and
fish are delivered directly by suppliers to some of our stores.  For certain other items, including 82% of
fruits and vegetables, we provide distribution to our supermarkets through our
distribution center.  For the year ended
December 31, 2004, approximately 23% of our sales 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 2004, Tnuvas products accounted for approximately 12.1% of all the
products sold at our
supermarkets. In addition, Elite, which merged with Strauss, an Israeli food
manufacturer, accounted for approximately 9.8% of all products sold at our
supermarkets in 2004, and the Osem group accounted for approximately 7.6% of
all products sold at our supermarkets in 2004.   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, Elite and Osem, we do not believe that there is a material risk of
future stoppage of supply of products of these key suppliers.  However, we do not have a written contract
with Tnuva, Elite or Osem obligating them to supply products to us.  In addition, in recent years, there has been
a process of consolidation among our suppliers.  As a result, our largest suppliers now account for a larger
percentage of our product purchasers.
The ten largest suppliers for our supermarkets accounted for
approximately 48% of our product purchases in 2004.  We have not experienced any material problems in obtaining
products of the quantity and type required.

Marketing

We
endeavor to create an awareness of our supermarkets as offering a combination
of broad selection, high-quality service and competitive prices.  Our primary advertising outlets, in addition
to point-of-sale marketing, are television, newspapers, radio, billboards and
direct mail.  Store promotions are
conducted, from time to time, in all our supermarkets, in specific chains or in
individual stores.  These promotions
include our Mega club, Buy & Bonus incentive program, price reductions,
gifts, coupons or deferred payment terms.
We have joint advertising and sales initiatives together with some of
our suppliers.  The stores accept cash,
checks, credit cards and gift certificates.
We provide extended payment terms for supermarket purchases.  During the High Holiday and Passover
seasons, we run gift certificates programs, under which we issue and sell gift
certificates to institutions, companies and individuals.  The gift certificates can be used in our
stores as well as other stores with which we entered into collaboration
agreements.  We also participate in
tenders in connection with the sale of our gift certificates, and we are
conducting pilot programs with respect to the use of prepaid electronic cards
which would be used as a substitute for paper gift certificates.  From time to time, we also operate joint
marketing promotions with other entities.

21

---

---



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

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 prices of goods and services
offered in Israel.  Any imposition of
more extensive price controls in the future than those that currently exist may
have a material adverse effect on our operating results. See Item 3. Key
Information- Risk Factors- D. Government-imposed price controls may have a material
adverse to effect on our operating results for more information.

Deposits for Drink Containers

A
law effective October 1, 2001 requires stores to charge a deposit for drink
containers of less than 1.5 liters and more than 0.1 liter and accept the
return of empty containers for refund.
The Knesset, the Israeli parliament, is considering an amendment to this
law which, among other things: (i) would require stores to also charge a
deposit for drink containers of 1.5 liters and more and accept the return of
empty containers for refund; (ii) would limit to 50 the number of containers
which a store is required to accept from any customer on any single day; (iii)
the obligation to recycle the containers would be under the responsibility of
the producers and/or the importers of the containers and (iv) would impose an
affirmative duty on employers to supervise and to use their best efforts to
prevent violations of the law by their employees. Under the proposed amendment,
an employer may be held criminally liable for breaching its duty to prevent
employee violations of the law. See Item 3. Key Information  D. Risk Factors
 The proposed amendment to the Law of Deposits on Beverage Containers, 1999,
would impose significant expenses and costs on us, which could have a material
adverse effect on our results of operations.
Blue Square is no longer a participant in the activities of a recycling
corporation whose purpose is to set up and operate a mechanism to implement the
provisions of the law.  We have
commenced a lawsuit against the recycling corporation for the reimbursement of
expenses that the recycling corporation was obligated to reimburse Blue Square
under the agreement between the founders of the recycling corporation and the
recycling corporation.  We have incurred
expenses to allocate storage space for the empty containers and dedicate
special cashiers for returning the deposits.
We have also incurred expenses for additional personnel and equipment,
including equipment in some of our stores that enable consumers to
automatically receive their deposits while bringing back the empty containers
without the need for store personnel.
For information regarding a claim under the new law, See Item 8.
Financial information- A. Consolidated Statements and Other Financial
Information - Legal Proceedings.

22

---

---



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.

Interchange
Commission Rates

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

Arrangements
between Major Supermarkets Chains and Large Suppliers

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

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

23

---

---



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

|  |                                                                                                                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The legal
  department of the Israeli Antitrust Authority is to take appropriate legal
  proceedings against any party to a clear violation of the law exposed during
  the investigation and, if necessary, take prospective legal measures, such as
  injunctions and issuing directives to monopolists.
|  |                                                                                                                                                                                                                                                                                                           
| | Demand from
  the relevant supermarket retail chains and food suppliers to provide all existing agreements and arrangements with regard to year
2004 in order to ensure that the
  illegal practices have ceased and that the recommendations of the
  Commissioner have been implemented.                
|  |                                                                                                                                                                                                                                                                                                           
| | 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. For example, the following
  arrangements must be submitted to the antitrust tribunal or the Commissioner
  for review: (i) an agreement granting a dominant supplier an allocation
  exceeding half of the overall display area designated for the product
  category in which he has dominance; (ii) acquiring exclusivity for various
  off-shelf displays for extended periods of time or during high volume sale
  periods; (iii) long-term agreements regarding the acquisition of display
  areas, which impede potential competition.
  The following arrangements are deemed to pose no threat to
  competition: (i) arrangements with retailers who posses small market share;
  (ii) arrangements where the allocation of the display area to a particular
  supplier is very small; (iii) short-term arrangements; and (iv) arrangements
  with small suppliers.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | Category management by a dominant supplier must be subject to the
  review of antitrust authorities review.
  Category management by a retail chain with a supplier constitutes a
  restrictive arrangement, but is not completely proscribed and will be
  reviewed by the antitrust authorities on a case-by-case basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

24

---

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The use of suppliers representatives
  to physically arrange the shelves in the chains stores constitutes a
  restrictive arrangement and must be submitted to the antitrust tribunal for
  approval or to the Commissioner for exemption. Accordingly, a six-month
  transition period has been set for the discontinuance of such practices or
  for obtaining appropriate approvals.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | 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.
  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 no enforcement will be executed for such
  arrangements, provided that (i) a large retail chain and a dominant supplier
  shall not be party to an agreement whose object or effect is the granting of benefits in return






















  for meeting sales goals, unless the benefit is given as only a discount to
  the purchase price of units sold in excess of the sales goals and is
  restricted to these units alone; and (ii) the prices of units sold in excess
  of the sales goals shall not be lower than the production costs of these
  units.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | 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
  distinguished between three types of agreements: (i) a minimum retail price
  arrangement is proscribed; (ii) a maximum retail price arrangement, although
  restrictive, generally will be approved by the antitrust authorities; and
  (iii) a recommended resale price by the supplier is not, by itself, a
  restrictive arrangement so long as the supplier takes no action which is
  intended to result in the retailer accepting the suppliers recommendation.                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | 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 retail chains are entitled to
  demand from their suppliers the best possible commercial terms, provided they
  do not link these demands to the commercial terms other competing chains
  receive from these suppliers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

25

---

---



| |   |                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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, 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 have begun negotiations with the
Commissioner with respect to the contents of the consent decree. 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.

We
understand from recent press reports that the Commissioner has delivered to the
large suppliers a draft of a proposed consent decree. We have not received
confirmation that this has occurred, nor do we have any knowledge regarding the
content of such consent decree or the response of the large suppliers to any
such consent decree.

Consumer
Protection Laws

We
are obligated to label prices on our products on the basis of two main laws:
The Consumer Protection Law,
1981, and the Commodities and Services
(Control) Law, 1957.
Contravention of these laws constitutes a criminal offense.  As a result, we expect to be charged in
connection with discrepancies between the prices appearing on products, and the
prices charged by the cash register at the point of sale. These discrepancies
are the result of human error by personnel responsible for labeling our products.
In any event, we are making our best efforts to minimize these errors,
including directing store management, in situations where a discrepancy is
found between the price on a product and the price appearing at the cash
register, to charge the lower price.

26

---

---



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
addition, pursuant to new proposed regulation to be promulgated under the Consumer Protection Law, sellers of new
electrical appliances to the end user consumer would be required to assume the
responsibilities of the manufacturer(s) of the appliances in the event such
manufacturer declares bankruptcy, is insolvent or otherwise cannot be
located. Such responsibilities would
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 maintaining or
subcontracting service centers.

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.

Pursuant to
a new amendment to the Pharmacy Ordinance effective May 2005, over-the-counter pharmaceutical medical products (OTC
drugs) may be sold by individuals other than pharmacists and in places other
than drugstores. We have applied for
licenses to sell OTC drugs in some of our stores, and some of our applications
have already been approved. We are
subject to certain obligations and requirements regarding the sale of OTC
drugs, among them: appointment of a supervisor in each store that sells OTC
drugs, requirements relating to the size, composition, sanitation, temperature
and safety of the stores selling OTC drugs, storage requirements, signage
requirements, maximum selling quotas to individual consumers, restrictions on
sales to minors, restrictions on advertising and promotion and requirements to
pay license and renewal fees.

New
Proposed Business License Regulation

By virtue
of The Businesses License Law, 1968,and
the regulations promulgated thereunder, and as a condition of the receipt of
permits, we are required to comply with various safety, security, health,
environment and other requirements.
Under the proposed new Businesses
License Regulation (Proper Sanitation Conditions to Grocery)  2004, some existing requirements will be tightened and new requirements will be
imposed on the operation of our stores.
The new regulation would contain new or more stringent requirements
relating to the following: requirements as to the building of our stores,
designation of separated space to some specialty departments, drainage system
requirements, sanitation, ventilation, lighting, temperature, water, sewage,
waste handling, food storage, signage, food transportation and maintenance
requirements, cooling device requirements and display and quality
requirements. This proposed new Business License Regulation, would impose
significant expenses and costs on us if it were become effective.

27

---

---



C.        Organizational
Structure

We
operate all of the supermarkets, including 104 of the supermarkets that are
directly owned by Blue Square, and the remaining supermarkets which are owned
by BSIPs subsidiaries. Stores owned by
BSIPs subsidiaries generated approximately 68% of our sales during 2004. Each of BSIP and its subsidiaries has its
own board of directors. We appoint all
or a majority of the board of directors of each of these companies and
typically our appointee serves as the chairman of the board of directors of
each company. Although we appoint all
or most of the board of directors of each company, each companys board of
directors has independent fiduciary obligations to all of its shareholders and
to the company itself. Blue Square is
obligated to deal with its partially owned subsidiaries at arms-length. Moreover, in the case of BSIP, which
is
publicly traded on the Tel Aviv Stock Exchange, the board of directors must
include two external directors appointed under Israeli law. These external directors must satisfy all
the requirements of external directors under the Israeli Companies Law, 1999,
referred to as the Israeli Companies Law.

Our
largest subsidiary is BSIP, of which Blue Square owned approximately 80.7% of
the outstanding shares as of December 31, 2004. The balance of BSIPs outstanding shares are publicly held and
traded on the Tel Aviv Stock Exchange.
BSIP, in turn, owns all of the outstanding shares of Hyper Hyper, which,
as indicated in the table set forth below, is the owner of our interests in a
number of its other subsidiaries and affiliates. Blue Square receives fees from its subsidiaries, including BSIP
and Hyper Hyper, as payment for the management and consulting services it
provides to them for purchasing, marketing, finance, store development, budgets
and control, accounting and financial reporting, taxation, law, internal
auditing and data processing services.
See Item 7. Major Shareholders
and Related Party Transactions  B. Related Party Transactions.  For information concerning the flow of funds
between Blue Square and its direct and indirect subsidiaries, see also Item
5. Operating and Financial Review and
ProspectsLiquidity and Capital Resources.

28

---

---



Set
forth below is a list of our material holdings as of June 15, 2005. The company marked with an asterisk (*) is
not consolidated in our financial statements.

|                                                      |  |              |                                              |                                       |  |  |     
|----------------------------------------------------- |  | ------------ | -------------------------------------------- | ------------------------------------- |  |  | ----
|Company(1)                                            |  | Operations + |                                              | % Ownership 
  Held by Blue 
  Square | 
|                                                      |  |              |                                              |                                       | 
|                                                      |  |              |                                              |                                       |  |  |     
|The
  Blue Square Chain Investments & Properties Ltd. |  |              | Real
  estate and supermarkets               |                                       |  |  | 80.7
|The
  Blue Square Chain (Hyper Hyper) Ltd.            |  |              | Supermarkets                                 |                                       |  |  | 80.7
|Radio
  Non Stop Ltd.*                                |  |              | Local
  radio station                        |                                       |  |  | 26.6
|Hamachsan Hamerkazi Kfar Hashaashuim Ltd.            |  |              | All for a Dollar, toy and houseware stores |                                       |  |  | 50  

| |                                                                                                               |                                                                                                                                                                                                            
| | ------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1)                                                                                                           | All companies are
  incorporated under Israeli law.                                                                                                                                                        
| |                                                                                                               |                                                                                                                                                                                                            
| | (2)                                                                                                           | The remaining shares of
  BSIP are held by the public and institutional investors and traded on the Tel
  Aviv Stock Exchange.                                                                             
| |                                                                                                               |                                                                                                                                                                                                            
| | (3)                                                                                                           | BSIPs wholly owned
  subsidiary.                                                                                                                                                                          
| |                                                                                                               |                                                                                                                                                                                                            
| | (4)                                                                                                           | Hyper Hyper holds its
  interest in this company through a wholly owned subsidiary, which holds a 33%
  equity interest in Radio Non-Stop Ltd.
  The remaining interests are held by unaffiliated entities.
| |                                                                                                               |                                                                                                                                                                                                            
| | + We are also a 50% owner in a 17,000 square
  meter shopping mall in Jerusalem.                             
| |                                                                                                              
| | + In June 2005, we sold
  our holdings interest in Teco Ltd., a company which manufactures disposable
  bags.

29

---

---



D.        Property,
Plants and Equipment.

As
of December 31, 2004, we owned or leased approximately 480,300 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 1Israel Land
  Administration) |  |        | 92  |                         |  |  | 161,000 |  | 
|Leased under 5 years                                                 |  |        | 31  |                         |  |  | 60,000  |  | 
|Leased between 6-10 years                                            |  |        | 24  |                         |  |  | 47,500  |  | 
|Leased over 10 years                                                 |  |        | 17  |                         |  |  | 31,500  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|                                                                     |  |        | 164 |                         |  |  | 300,000 |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|Stores in Development                                                |  |        |     |                         |  |  |         |  | 
|Owned                                                                |  |        | 2   |                         |  |  | 2,100   |  | 
|Leased between 5-25 years                                            |  |        | 7   |                         |  |  | 14,800  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|                                                                     |  |        |     |                         |  |  | 16,900  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|Owned Offices (Rosh Haayin)                                         |  |        | 1   |                         |  |  | 9,300   |  | 
|Owned Warehouses (Rishon Letzion, Kiriat Gat, Kfar Saba)             |  |        | 3   |                         |  |  | 26,000  |  | 
|Leased Warehouses (Barkan)                                           |  |        | 1   |                         |  |  | 2,500   |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|                                                                     |  |        |     |                         |  |  | 37,800  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|Undeveloped Land (1)                                                 |  |        |     |                         |  |  | 84,000  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|Leased to Third Party (2)(3)                                         |  |        |     |                         |  |  | 17,600  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|Unutilized Properties                                                |  |        |     |                         |  |  | 24,000  |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 
|TOTAL                                                                |  |        |     |                         |  |  | 480,300 |  | 
|                                                                     |  |        |     |                         |  |  |         |  | 

| |     |                                                                                                                                                       
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | The figures in this table
  do not include building rights.                                                                                           
| |     |                                                                                                                                                       
| | (2) | Including a 50% interest
  owned by Blue Square in a 17,000 square meter shopping mall in Jerusalem, in
  which we operate a 5,000 square meter store.
| |     |                                                                                                                                                       
| | (3) | Including a 50% interest
  owned indirectly by BSIP in a 7,100 square meter shopping mall in Beer
  Sheva.                                           

30

---

---



In
2005, we opened and plan to open approximately six additional supermarkets,
totaling approximately 10,400 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.During 2005, we also closed or plan to close
approximately three stores, totaling approximately 3,400 square meters of store
space.
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 90 million, or $21 million on the acquisition and development of
new supermarkets and the remodeling of our existing supermarkets through the end
of 2005.

Most
of our acquisitions of real estate have been in connection with the retail
operation of our stores. Nevertheless,
through our Real Estate Development Division, we are exploring various
alternatives to maximize the potential value of our real estate assets,
including our unused building rights.
Among the alternatives, we will consider methods to raise capital
through our real estate assets (such as an offering to the public,
securitizations of cash flow, and sale and re-leasing of real estate on terms
more beneficial to us) and/or transfer of real estate to a subsidiary and/or
accepting third party investors in our real estate.

We
are also currently examining the feasibility of establishing and operating
gasoline stations on some of our properties.

|        |                                               
|------- | ----------------------------------------------
|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 2004 saw an improvement in Israels economic environment, as well as our
return to growth reflected in steadily rising revenues and same store sales,
after two years of decline. This
resulted from an improved economy, intensified marketing, consolidation of our
store formats into three well-differentiated brands and increase in our
efficiency.

31

---

---



In
recent years, due to a recession and an increase in unemployment in Israel, the
most important factor in the purchase decisions of a larger portion of the
Israeli public has been is the price of the products it purchases. Even following the economic recovery in
2004, the price of products has remained a significant factor in the purchase
decisions of many consumers. In
response to the increased focus on the price of products, private supermarkets
have continued to expand their presence in selected areas, increasing
competition in an already difficult market.
These private supermarkets have been able to capture a significant part
of the sales from the major chains in their areas by using lower cost
non-unionized labor and having lower operating costs and, in some cases by
operating on Saturdays and offering non-kosher food. Large supermarket chains
in Israel, including us, are kosher and therefore do not offer non-kosher food
or operate on Saturdays. We and other
major chains have also responded to consumers increased focus on the price of
products by continuing our expansion into low-price store formats, and during
2005, other major chains have expanded into hard discount store formats.

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

During
2004, 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
2004 by increases to our regional sales volumes.

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

32

---

---



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, |       
| |                                                    |  |                         |       
| |                                                    |  | 2002                    |        | 2003 |  | 2004   |  
| |                                                    |  |                         |        |      |  |        |  
| |                                                    |  | %                       |        | %    |  | %      |  
| | Sales                                              |  |                         | 100.00 |      |  | 100.00 |   |  | 100.00 | 
| | Gross
  profit                                     |  |                         | 26.99  |      |  | 26.94  |   |  | 26.16  | 
| | Selling,
  general and administrative expenses     |  |                         | 22.97  |      |  | 23.02  |   |  | 22.42  | 
| | Operating
  income                                 |  |                         | 4.02   |      |  | 3.92   |   |  | 3.73   | 
| | Taxes
  on income                                  |  |                         | 0.77   |      |  | 0.16   |   |  | 0.77   | 
| | Minority
  interest in profit of subsidiaries, net |  |                         | 0.11   |      |  | 0.21   |   |  | 0.25   | 
| | Net
  income (loss)                                |  |                         | 0.13   |      |  | (0.14  | ) |  | 1.13   | 

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

Sales. Sales in 2004 were approximately NIS 5,366 million, or
$1,246 million, an increase of approximately 3.8% compared with sales of
approximately NIS 5,171 million, or $1,200 million in 2003. This increase in
sales reflects the success of the Companys brand consolidation and expansion
programs during the year. Over the
course of the year, we converted all stores into three well-differentiated
brands: MEGA, SuperCenter and Shefa Shuk.

Gross
profit. Gross profit in 2004 was approximately NIS
1,403 million, or $326 million, an increase of 0.7% compared with gross profit
of approximately NIS 1,393 million, or $323 million in 2003. This increase in
gross profit reflected the higher level of sales mitigated by a decrease in the
gross margin to 26.2% in 2004 compared to 26.9% in 2003. This reflects an
increase in discounted sales as a percentage of the overall sales mixture due
to the Companys brand consolidation program, especially the conversion of
Co-Op stores to Super Centers and Super Centers to Megas and Shefa Shuks,
offset somewhat by improved buying terms with suppliers.

Operating
and administrative expenses.Operating and
administrative expenses in 2004 were approximately NIS 1,203 million, or $279
million, an increase of 1.1% compared with operating and administrative expenses
of approximately NIS 1,190 million, or $276 million in 2003. This increase is
attributable to the Companys addition of new stores during the year. However,
Selling, General & Administrative Expenses (SG&A) declined as a
percentage of revenues to 22.4% from 23.0% in 2003. This illustrates the
ongoing success of the Companys efficiency efforts.

33

---

---



Operating
income. Operating income in 2004 was approximately NIS
200 million, or $46 million, a decrease of 1.3% compared with approximately NIS
203 million, or $47 million in 2003, resulting in an operating margin for the
year of 3.7% compared to 3.9% in 2003.
The decrease in operating income and operating margin was due to a
decrease in gross margin offset somewhat by a decrease in expenses.

Financial
income (expenses), net. Financial expenses, net in 2004
were approximately NIS 58 million, or $13 million, compared with financial
expenses, net of approximately NIS 49 million, or $11 million in 2003. The higher level of financial expenses for
2004 reflects increased total debt following the Companys issuance of
debentures in August 2003, together with dividend payments made during the
year.

Other
expenses, net. Other expenses, net in 2004 were
approximately NIS 20 million, or $5 million, compared with other expenses, net
of approximately NIS 137 million, or
$32 million in 2003. The 2004 charges
consisted primarily of the following:

| |  | a
provision of NIS 8.4 million (U.S. $1.9 million) in respect of   impairment of assets
according to Israeli GAAP Accounting Standard No. 15   (impairment of assets) and closure
of stores;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | NIS
4.7 million (U.S. $1.1 million) related to dismissal of employees   from the Companys
Headquarters; and
| | - | ------------------------------------------------------------------------------------------------------------

| |  | NIS
4.5 million (U.S. $1.0 million) as a compensation payment for the   termination of a
private label contract.
| | - | ----------------------------------------------------------------------------------------------------------------

Other
Expenses for 2003 included a one-time provision of NIS 67.5 million for store
closures and employee dismissals and a non-recurring expense of NIS 63.9
million related to an agreement between the Company and its employees.

Taxes
on income. Taxes on income in 2004 were NIS 41.2
million, or $9.6 million, compared with approximately NIS 8.4 million, or $2.0
million, in 2003. As a percentage of income before taxes on income, taxes on
income decreased to approximately 35.4% in 2004, compared with 73.4% in 2003.
This higher effective tax rate applicable to us in 2003 primarily resulted from
our incurrence of a significantly higher amount of non-deductible expenses in
2003 resulting mainly from the operation of Accounting Standard No. 15,
Impairment of Assets. In 2004, the
Companys nominal tax rate was reduced from 36% to 35% in accordance with the
Income Tax Ordinance Amendment adopted on June 29, 2004, which provides for the
gradual reduction in the rate of corporate tax commencing from January 1, 2004.
Further reductions will come into effect at the beginning of 2005, 2006, and
2007 until a final tax rate of 30% is achieved.

Minority
interest in profit of subsidiaries, net. Minority interest in profit ofsubsidiaries, net in 2004 was
approximately NIS 13.6 million, or $3.2 million, an increase of 24.9% compared
with approximately NIS 10.9 million, or $2.5 million in 2003. This increase in minority interest in profit of subsidiaries, net is primarily
attributable to the increase in the net income of BSIP in 2004.

34

---

---



Net
income. Net
income in 2004 was approximately NIS 60.5 million, or $14.0 million compared with a net loss of approximately NIS 7.0
million, or $1.6 million in 2003.

Year Ended December 31, 2003 compared with
year ended December 31, 2002

Sales. Sales in 2003 were approximately NIS 5,171 million, or
$1,200 million, a decrease of approximately 5% compared with sales of approximately
NIS 5,444 million, or $1,264 million in 2002. This decrease in sales is
primarily attributable to the recession in the Israeli economy in 2003,
competition and the closing of underperforming stores. In 2003, same store
sales decreased by 11.2% due to the opening of additional stores by our
competitors and us, competition and a slowdown in general economic growth in
the Israeli economy.

Gross
profit. Gross profit in 2003 was approximately NIS
1,393 million, or $323 million, a decrease of 5.2% compared with gross profit
of approximately NIS 1,470 million, or $341 million in 2002. This decrease in gross profit is primarily
attributable to the decrease in our sales.
As a percentage of sales, gross profit decreased to 26.9% in 2003 from
27.0% in 2002. This decrease is primarily attributable to the increased share
of sales from our discount stores and to the increased competition in the food
retail chains in Israel. The reduction
in gross profit was mitigated by the effect of the CPI on our opening
inventory; the CPI decreased by 1.9% in 2003 as compared to an increase of 6.5%
in 2002. In general, a rise in the CPI
erodes the gross profit. From periods
beginning or following January 2004, this effect will be disregarded as our
financial statements will cease to be adjusted for inflation in Israel going
forward in accordance with Israeli Accounting Standards No. 12 and No. 17.

Operating
and administrative expenses.Operating and
administrative expenses in 2003 were approximately NIS 1,190 million, or $276
million, a decrease of 4.8% compared with operating and administrative expenses
of approximately NIS 1,251 million, or $290 million in 2002. This decrease in
expenses was primarily the result of our ongoing efforts to increase our
operating efficiency, and a decrease in depreciation as a result of the write
down of fixed assets at the end of 2002 offset by increases in credit card
charges and electricity costs due to an increase in electricity rate charges.

Operating
income.Operating income in 2003 was approximately NIS
203 million, or $47 million, a decrease of 7.5% compared with approximately NIS
219 million, or $51 million in 2002.
As a percentage of sales, operating income in 2003 was 3.9% compared
with 4% in 2002.  This decrease in
operating income is primarily attributable to the decrease in sales and gross
profit.

Financial
income (expenses), net. Financial expenses, net in
2003 was approximately NIS 49 million, or $11 million, compared with financial
income, net of approximately NIS 16 million, or $3.7 million in 2002.  The majority of this increase in financial
expense, net is attributable to the substantial difference in the CPI for the
two years: during 2003 the CPI declined by 1.9%, resulting in an appreciation
of our net monetary unlinked liabilities leading to an increase in financial
expenses, while in 2002 it increased by 6.5%, resulting in financial income. In
addition the increase also reflects our issuance of debenture and payment of
dividends during the year. The effect of any change in the CPI will be
disregarded in future periods as our financial statements will cease to be
adjusted for inflation in Israel in accordance with Israeli Accounting
Standards No. 12 and No. 17.

35

---

---



Other
expenses, net. Other expenses, net in 2003 were
approximately NIS 137 million, or $31.7 million, compared with other expenses,
net of approximately NIS 174 million, or $40 million in 2002. The 2003 charges consisted primarily of the
following:

|  |                                                                                                                                                                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a provision of approximately NIS 26 million in respect of the
  dismissal of approximately 250 employees as described above                                                                                                                                                                                  
|  |                                                                                                                                                                                                                                                                                                              
| | a provision of NIS 41.6 million in respect of impairment of fixed
  assets and the planned closure of unprofitable stores                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                              
| | a one-time expense of NIS 63.9 million recorded in the second quarter
  related to agreements reached between Blue Square and its employees after the
  change in Blue Squares control, according to which Blue Squares employees
  are entitled to receive certain bonuses and additional future benefits.

Taxes
on income. Taxes on income in 2003 were NIS 8.4
million, or $2 million, a decrease of 80% compared with approximately NIS 42.1
million, or $9.8 million in 2002.  As a
percentage of income before taxes on income, taxes on income decreased to
approximately 73.4% in 2003, compared with 75.6% in 2002.  This high effective tax rate is primarily
attributable to an increase in taxes resulting from nondeductible expenses.

Minority
interest in profit of subsidiaries, net. Minority interest in profit ofsubsidiaries, net in 2003 was
approximately NIS 10.9 million, or $2.5 million, an increase of 82% compared
with approximately NIS 6.0 million, or $1.4 million in 2002.  This increase in minority interest profit of in
subsidiaries, net is
primarily attributable to the increase in the net income of BSIP in 2003.

Net
income (loss). Net
loss in 2003 was approximately NIS 7 million, or $1.6 million, compared with a net income of approximately NIS 7.2
million, or $1.7 million in 2002.

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.

36

---

---



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

The
following table sets forth certain quarterly information. Until periods
beginning on or after January 1, 2004, our financial statements were presented
in NIS adjusted to reflect changes in the Israeli consumer price index, or the
CPI.

|               |  |                |  |                              |  |     |                |                              |       |   |  |  |  |        |  |  |  |  |       |   | 
|-------------- |  | -------------- |  | ---------------------------- |  | --- | -------------- | ---------------------------- | ----- | - |  |  |  | ------ |  |  |  |  | ----- | - | 
|               |  | Net sales      |  | Operating income             | 
|               |  |                |  |                              | 
|               |  | NIS            |  | Percentage 
  of
  Full Year |  | NIS |                | Percentage
  of 
  Full Year |      
|               |  |                |  |                              |  |     |                |                              |      
|               |  | (In thousands) |  |                              |  |     | (In thousands) |                              |       |   | 
|2004           |  |                |  |                              |  |     |                |                              |       |   |  |  | 
|First quarter  |  |                |  | 1,285,876                    |  |     |                |                              | 23.97 | % |  |  |  | 50,053 |  |  |  |  | 25.02 | % | 
|Second quarter |  |                |  | 1,318,452                    |  |     |                |                              | 24.57 | % |  |  |  | 56,088 |  |  |  |  | 28.03 | % | 
|Third quarter  |  |                |  | 1,384,523                    |  |     |                |                              | 25.80 | % |  |  |  | 51,260 |  |  |  |  | 25.62 | % | 
|Fourth quarter |  |                |  | 1,376,933                    |  |     |                |                              | 25.66 | % |  |  |  | 42,689 |  |  |  |  | 21.33 | % | 
|               |  |                |  |                              |  |     |                |                              |       |   |  |  |  |        |  |  |  |  |       |   | 
|2003(1)        |  |                |  |                              |  |     |                |                              |       |   |  |  |  |        |  |  |  |  |       |   | 
|First quarter  |  |                |  | 1,192,818                    |  |     |                |                              | 23.07 | % |  |  |  | 31,230 |  |  |  |  | 15.41 | % | 
|Second quarter |  |                |  | 1,342,881                    |  |     |                |                              | 25.97 | % |  |  |  | 50,509 |  |  |  |  | 24.92 | % | 
|Third quarter  |  |                |  | 1,339,242                    |  |     |                |                              | 25.90 | % |  |  |  | 56,474 |  |  |  |  | 27.86 | % | 
|Fourth quarter |  |                |  | 1,295,569                    |  |     |                |                              | 25.06 | % |  |  |  | 64,461 |  |  |  |  | 31.81 | % | 

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

Exchange Rates

At
December 31, 2004, the representative rate of exchange of the NIS to the
dollar, as published by the Bank of Israel, was NIS 4.308 = $1.00. At
June 15, 2005, the representative rate of exchange of the NIS to the dollar, as
published by the Bank of Israel, was NIS 4.482 = $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, 2000 through 2004:

|                           |  |  |            |  |  |                 |  |  |      |  |  |      | 
|-------------------------- |  |  | ---------- |  |  | --------------- |  |  | ---- |  |  | ---- | 
|Year Ended 
  December 31, |  |  | Period End |  |  | Average Rate(1) |  |  | High |  |  | Low  | 
|                           |  |  |            |  |  |                 |  |  |      |  |  |      | 
|                           |  |  |            |  |  | (NIS per $1.00) |  |  |      |  |  |      | 
|                           |  |  |            |  |  |                 |  |  |      |  |  |      | 
|2000                       |  |  | 4.04       |  |  | 4.08            |  |  | 4.20 |  |  | 3.97 | 
|2001                       |  |  | 4.42       |  |  | 4.21            |  |  | 4.42 |  |  | 4.07 | 
|2002                       |  |  | 4.74       |  |  | 4.74            |  |  | 4.99 |  |  | 4.44 | 
|2003                       |  |  | 4.38       |  |  | 4.55            |  |  | 4.92 |  |  | 4.28 | 
|2004                       |  |  | 4.31       |  |  | 4.48            |  |  | 4.63 |  |  | 4.31 | 

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

37

---

---



The
following table sets forth certain information concerning the representative
exchange rate of the NIS to the dollar, as published for the months January
through May 2005.

|         |  |  |            |  |  |                 |  |  |      |  |  |      | 
|-------- |  |  | ---------- |  |  | --------------- |  |  | ---- |  |  | ---- | 
|Month    |  |  | Period End |  |  | Average Rate(1) |  |  | High |  |  | Low  | 
|         |  |  |            |  |  |                 |  |  |      |  |  |      | 
|         |  |  |            |  |  | (NIS per $1.00) |  |  |      |  |  |      | 
|         |  |  |            |  |  |                 |  |  |      |  |  |      | 
|January  |  |  | 4.38       |  |  | 4.38            |  |  | 4.41 |  |  | 4.35 | 
|February |  |  | 4.36       |  |  | 4.37            |  |  | 4.39 |  |  | 4.36 | 
|March    |  |  | 4.36       |  |  | 4.33            |  |  | 4.38 |  |  | 4.30 | 
|April    |  |  | 4.37       |  |  | 4.37            |  |  | 4.40 |  |  | 4.36 | 
|May      |  |  | 4.42       |  |  | 4.37            |  |  | 4.42 |  |  | 4.35 | 

|    |                                         
|--- | ----------------------------------------
|(1) | The average of the daily exchange rates.

Impact of Inflation and Currency Fluctuations

Inflation
in Israel increases our expenses, which, because of competitive pressures, are
generally not offset, fully or as quickly, by increases in our selling prices
and revenues. In addition, any
devaluation of the NIS against various non-Israeli currencies in which we or
our suppliers pay for imported goods, has the effect of increasing the NIS cost
of these goods.

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

Beginning
January 1, 2004, our financial statements ceased to be adjusted for inflation
in accordance with Israeli Accounting Standards No. 12 and No. 17 adopted by
the Israeli Accounting Standards Board.
As a result of the adoption of these standards, 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, although recently they have somewhat
decreased. 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; the future effect of the continuance of these
hostilities on the Israeli economy and our operations is unclear. During the past year, in an effort to reduce
hostilities, the Government of Israel announced plans to withdraw from the Gaza
Strip area as well as a small portion of the northern West Bank during the
upcoming summer. It is unclear what
effect such disengagement would have on the Israeli economy and on our
operations.

38

---

---



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 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 the years 2001 and 2002, Israels Gross Domestic Product declined
by 0.9% and 0.7%, respectively, while in 2003 and 2004 it increased by 1.3 %
and 4.3%, respectively. Initial reports indicate that the Israeli
economy will grow by approximately 4.0% in 2005. We cannot be sure how any growth or decline in the Israeli
economy will affect our financial performance.

39

---

---



Trade Agreements

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

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

Corporate Tax Rate

We
are subject to income tax in Israel at the rate of 34% of taxable income.

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 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 the following manner: the rate for 2004 will be 35%, in 2005 -
34%, in 2006 - 32%, and in 2007 and thereafter - 30%.

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:

40

---

---



Impairment
of Assets

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

We
evaluate impairment separately for each store or other cash-generating unit. In
evaluating impairment, we consider corporate assets relating to the stores or
other cash-generating units as well as indirect costs that are directly
attributable, or that can be reasonably and consistently allocated, to the
stores or to other units. Goodwill is evaluated for impairment in relation to
the cash generating unit to which the goodwill can be allocated; mostly,
goodwill is allocated to the operations of the Companys principal consolidated
subsidiary, BSIP.

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

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

41

---

---



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

Rebates
from suppliers

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

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

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

Inventory

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

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

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

Compensation
for Unutilized Sick Leaves

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

42

---

---



Critical Accounting
Policies

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

Goodwill

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

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

Recently
issued accounting pronouncements in Israel

In
July 2004, the Israel
Accounting Standards Board issued Israeli Accounting Standard No. 19 - Taxes
on Income, which is based on International Accounting Standard No. 12, that
prescribes the accounting treatment (recognition criteria, measurement,
presentation and disclosure) required for taxes on income. This accounting
standard is to be applied to financial statements covering periods commencing
on, or after, January 1, 2005.

For
the most part, the provisions of this standard are the same as the accounting principles
that are customarily applied at present.
The adoption of the standard is not expected to have a material effect
on the Companys financial statements in the forthcoming periods.

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. Thus, at the operating level, there have generally been few, if
any, requirements for cash flow from Blue Square to its subsidiaries or from
these subsidiaries to Blue Square, except for cash payable to Blue Square under
management and other agreements. The
available cash resources of BSIP and its subsidiaries have historically been
used, and are expected to continue to be used, to finance the expansion of
these companies.

43

---

---



Cash
generated by operations was approximately NIS 349 million, or $80.9 million, in
2004, an increase of 35% compared with approximately NIS 259 million, or $60
million, in 2003, which, in turn, represented a decrease of 11% compared with
approximately NIS 291 million or $67.6 million, in 2002. This increase was primarily the result of an
advance payment of NIS 80 million made by credit card companies in year 2004
following their agreement to spread their payments to us more evenly during
each month, such that a portion of the payments by the credit card companies to
us are made earlier in the month, and a portion later in the month. In 2004, approximately 37.6% of our sales
were paid for with cash and cash equivalents at the point-of-sale,
approximately 61.6% of sales were paid for with credit cards and approximately 0.8%
of sales were paid for with other short-term credit arrangements.

During
2004, the average time period that we held inventory was 26 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 60 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 2004, we received long-term
borrowings of NIS 426.8 million, or $99 million. During 2004, we repaid NIS 357.6 or $83 million in long-term
borrowings and NIS 35 million or $8.2 million in short-term borrowings. In the first quarter of 2005, we received
long-term loans in the aggregate amount of NIS 120 million, which bear interest
at an average annual rate of 4.27% linked to the CPI.

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.

In
January 2005, we paid a dividend of $0.23 per share in the amount of
approximately NIS 39 million or $9 million.
In 2003 and 2004, we paid three dividends totaling approximately $127.2
million, equal to approximately $3.20 per share.

In
May 2004, BSIP paid a dividend totaling NIS 400 million or $93 million,
approximately NIS 320 million or $74 million of which was distributed to Blue
Square, and approximately NIS 80 million or $19 million was distributed to
other shareholders. BSIP financed the distribution in part by bank financing.

44

---

---



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 a capital
reserve that originated from a transaction in 1998 with a former controlling
shareholder. BSIP financed the distribution in part by bank financing.

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 2004, we
invested approximately NIS 89.4 million, or
$20.8 million in fixed and other assets, in the development of new
stores and in existing store renovation and remodeling, a decrease of 35.5%
compared with approximately NIS 139 million, or $32.2 million during 2003 which, in turn, represented a decrease
of 43% compared with approximately NIS 243 million, or $56.4 million during
2002. This decrease was primarily
attributable to our continued strategy of leasing store sites with option to
renew the leases other than to purchase store sites and our opening of fewer
stores than in 2002. We currently plan to spend in excess of NIS 90 million, or
$21 million for the development or acquisition of new supermarkets, the
renovation and remodeling of our existing supermarkets and related investments
through the end of 2005. We intend to
finance our store development, renovation, modeling, expansion and acquisitions
mainly from cash generated by our operations.

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

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

|                                     |  |  |                                      |  |  |         |  |  |         |  |  |         |  |  |         |  |  |                                |  |  |           | 
|------------------------------------ |  |  | ------------------------------------ |  |  | ------- |  |  | ------- |  |  | ------- |  |  | ------- |  |  | ------------------------------ |  |  | --------- | 
|                                     |  |  | Expected Maturity (NIS in thousands) | 
|                                     |  |  |                                      | 
|                                     |  |  | 2005                                 |  |  | 2006    |  |  | 2007    |  |  | 2008    |  |  | 2009    |  |  | From 
  2010 and 
  thereafter |  |  | Total     | 
|                                     |  |  |                                      |  |  |         |  |  |         |  |  |         |  |  |         |  |  |                                |  |  |           | 
|                                    
|Long term loans from banks (1)       |  |  | 136,517                              |  |  | 227,786 |  |  | 135,506 |  |  | 14,583  |  |  | 8,333   |  |  | 4,167                          |  |  | 526,892   | 
|Non-Convertible Debentures (2) (3)   |  |  | -                                    |  |  | -       |  |  | -       |  |  | -       |  |  | -       |  |  | 200,000                        |  |  | 200,000   | 
|Convertible Debentures (2) (4)       |  |  | -                                    |  |  | -       |  |  | 62,064  |  |  | -       |  |  | 62,064  |  |  | 62,065                         |  |  | 186,193   | 
|Non-cancelable Long term leases      |  |  | 114,049                              |  |  | 115,266 |  |  | 108,592 |  |  | 93,253  |  |  | 80,431  |  |  | 346,905                        |  |  | 858,496   | 
|                                     |  |  |                                      |  |  |         |  |  |         |  |  |         |  |  |         |  |  |                                |  |  |           | 
|Total contractual cash
  obligations |  |  | 250,566                              |  |  | 343,052 |  |  | 306,162 |  |  | 107,836 |  |  | 150,828 |  |  | 613,137                        |  |  | 1,771,581 | 

| |     |                                                                                                                                                                                                                                                                                                                                                                                      
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | This table
  does not include payments of interest on our long-term bank loans, due to its
  unpredictable nature. As of December 31, 2004, most of our long-term bank
  loans were either linked to the Israeli CPI, bore interest at variable rates
  of interest or were linked to changes in the exchange rate with a foreign
  currency. See Long-Term Loans from Banks below.

45

---

---



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | 
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | (2) | These
  debentures bear interest at an annual rate of 5.9% and are linked (principal
  and interest) to the Israeli CPI, but in the event the Israeli CPI is less
  than the base index (index known at date of issuance), the amount of
  debentures will not be adjusted below the base index. Without taking into
  account any changes to the Israeli CPI, interest payments on the
  Non-Convertible Debentures would be NIS 11,800 in 2005, NIS 11,800 in 2006,
  NIS 11,800 in 2007, NIS 11,800 in 2008, NIS 11,800 in 2009 and NIS 42,441 in
  2010 and thereafter. Without taking
  into account any changes to the Israeli CPI, interest payments on the
  Convertible Debentures would be NIS 10,985 in 2005, NIS 10,985 in 2006, NIS
  9,508 in 2007, NIS 7,323 in 2008, NIS 5,847 in 2009 and NIS 5,847 in 2010 and
  thereafter. The table above does not
  include payments of interest on our debentures because the actual interest
  payments on these debentures will depend on changes in the Israeli CPI, which
  cannot be predicted at the time of this report. | 
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | 
| | (3) | The
  principal is repayable in three equal annual installments on August 5 of each
  of the years 2012 to 2014. Notwithstanding the above, on August 5 of each of the years 2006, 2008
  and 2010, the holders of the debentures will be entitled to early redemption
  of the principal provided that on each of the said dates, we will not repay
  more than one third of the par value of the debentures outstanding as of that
  date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | 
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | 
| | (4) | The
  principal is repayable in three equal annual installments on August 5 of each
  of the years 2007, 2009, and 2011.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | 

As
of December 31, 2004, Blue Square had entered into agreements for investments
in fixtures and equipment in the aggregate amount of approximately NIS 12
million, or $2.8 million.

Dividends

In
January 2005, Blue Square distributed to its shareholders a dividend of $0.23
per share in an aggregate amount of approximately NIS 39 million or $9 million.

During
2004, Blue Square distributed to its shareholders a dividend of $1.48 per share
in an aggregate amount of approximately NIS 253 million or $58.7 million.

During
2003 Blue Square distributed to its shareholders a dividend of $1.72 per share
in aggregate amount of approximately NIS 295 million or $68.5 million.

During
2002, Blue Square distributed to its shareholders a dividend of $0.72 per share in an aggregate amount of approximately
NIS 128 million, or $29.7 million.

During
2001, Blue Square distributed to its shareholders a dividend of $0.31 per share
in an aggregate amount of approximately NIS 51.9 million, or $12 million.

Blue
Squares Board of Directors has resolved that we will not distribute dividends
in any quarter if the ratio of our financial obligations (as defined by Maalot,
an Israeli rating agency) to EBITDA for any quarter exceeds 3.5 until June 30,
2006 or exceeds 3.0 thereafter. Blue
Squares Board also resolved that Blue Square would not distribute dividends in
any quarter if the ratio of the cost of unencumbered fixed assets as set forth
on our financial statements (following depreciation) to financial obligations
(as defined by Maalot) for a quarter is below 120%.

46

---

---



Short-Term
Credit from Banks

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

| |                                         |  |                  |         |      |  |         | 
| | --------------------------------------- |  | ---------------- | ------- | ---- |  | ------- | 
| |                                         |  | December 31      |        
| |                                         |  |                  |        
| |                                         |  | 2003             |         | 2004 | 
| |                                         |  | NIS in thousands |        
| |                                         |  |                  |        
| | Short- term credit from banks           |  |                  |         |      |  |         | 
| | Unlinked                                |  |                  | 6,653   |      |  | 24      | 
| |                                         |  |                  |         |      |  |         | 
| | Linked to the Japanese Yen              |  |                  | 32,720  |      |  | -       | 
| |                                         |  |                  |         |      |  |         | 
| | Current
  maturities of Long-term loans |  |                  | 173,148 |      |  | 136,517 | 
| |                                         |  |                  |         |      |  |         | 
| |                                         |  |                  |         |      |  |         | 
| |                                         |  |                  | 212,521 |      |  | 136,541 | 
| |                                         |  |                  |         |      |  |         | 
| |                                         |  |                  |         |      |  |         | 

Long-Term
Loans from Banks

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

| |                            |  |                  |         |        |  |               |  |  |     |    
| | -------------------------- |  | ---------------- | ------- | ------ |  | ------------- |  |  | --- | ---
| |                            |  | December 31      |         |        | 
| |                            |  |                  |         | Annual | 
| |                            |  | 2003             |         | 2004   |  | Interest Rate | 
| |                            |  | NIS in thousands |         | %      | 
| |                            |  |                  |         |        | 
| | In
  foreign currency -    |  |                  |         |        |  |               |  |  |     |    
| | Swiss Frank                |  |                  | -       |        |  | 49,482        |  |  | 1.8 |    
| | In
  Israeli currency -    |  |                  |         |        |  |               |  |  |     |    
| | Linked to the Israeli CPI  |  |                  | 241,734 |        |  | 228,897       |  |  | 5.2 | (1)
| | Unlinked(2)                |  |                  | 217,498 |        |  | 248,513       |  |  |     |    
| |                            |  |                  |         |        |  |               |  |  |     |    
| |                            |  |                  | 459,232 |        |  | 526,892       |  |  |     |    
| |                            |  |                  |         |        |  |               |  |  |     |    
| | Less-
  current maturities |  |                  | 173,148 |        |  | 136,517       |  |  |     |    
| |                            |  |                  |         |        |  |               |  |  |     |    
| |                            |  |                  | 286,084 |        |  | 390,375       |  |  |     |    
| |                            |  |                  |         |        |  |               |  |  |     |    
| |                            |  |                  |         |        |  |               |  |  |     |    

| |                                                                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) Average fixed rate as of December 31, 2004                                                                                                                                                                             
| |                                                                                                                                                                                                                            
| | (2) As of December 31, 2004, includes NIS 172
  million at variable interest (average annual rate as of December 31, 2004-
  5%). The balance of approximately NIS 76 million is at a fixed annual
  interest rate of 6.8%.

47

---

---



Debentures

The
following table summarizes our outstanding debentures in 2003 and 2004:

| |                                     |  |                  |         |      |  |         | 
| | ----------------------------------- |  | ---------------- | ------- | ---- |  | ------- | 
| |                                     |  | December 31,     |        
| |                                     |  |                  |        
| |                                     |  | 2003             |         | 2004 | 
| |                                     |  |                  |         |      | 
| |                                     |  | NIS in thousands |        
| |                                     |  |                  |        
| |                                     |  |                  |         |      |  |         | 
| | Debentures (Series A)               |  |                  | 200,000 |      |  | 200,000 | 
| |                                     |  |                  |         |      |  |         | 
| |                                     |  |                  |         |      |  |         | 
| | Convertible debentures (Series
  B) |  |                  | 200,000 |      |  | 186,193 | 
| |                                     |  |                  |         |      |  |         | 

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 2004, convertible debentures (Series B) with
a par value of approximately NIS 13.8 million were converted into 382,336
ordinary shares.

Series
A Debentures

The
principal of the Series A Debentures is repayable in three equal annual
installments on August 5 of each of the years 2012 to 2014, and the interest is
payable semiannually. Notwithstanding
the above, on August 5 of each of the years 2006, 2008 and 2010, the holders of
the Series A Debentures will be entitled to early redemption of the principal
provided that on each of such dates we do not repay more than one third of the
par value of the Series A Debentures outstanding as of that date.

Series
B Debentures

The
principal of the Series B Debentures is repayable in three equal annual
installments on August 5 of each of the years 2007, 2009 and 2011, and the
interest is payable semiannually. The
Series B Debentures are convertible into our ordinary shares at a conversion
ratio that is subject to adjustment in the event of distribution of bonus
shares and cash dividends and the issuance of rights. As of December 31, 2004, each NIS 35.2 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, 2004. Subsequent to December 31,
2004, we distributed an additional dividend, which further reduced the
conversion ratio such that each NIS 34.2 par value of debentures are
convertible to one Ordinary shares of 1 NIS par value as of June 15, 2005.

48

---

---



Other
terms of the Series A and Series B Debentures

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

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

For
additional information on charges pertaining to the collateralized long-term
loans, see note 6a to our consolidated financial statements.

Commitments for Capital Expenditures

As
of December 31, 2004, we had entered into agreements for investments in
fixtures and equipment in the total amount of NIS 12 million, or $2.8
million. We intend to finance these
investments from cash generated by our operations.

C.        Research
and Development, Patents and Licenses.

Not applicable.

D.        Trend
Information.

We
estimate that growth opportunities for supermarkets in Israel remain as more
households increase purchasing of supermarket goods at supermarkets rather than
smaller grocery stores, mini-markets and open-air markets. We estimate that approximately 36% of the
total retail sales of food, beverages and tobacco in Israel in 2004 was made by
the three large chains and 50% was made by all chains - a percentage that is considerably lower than the estimated
market shares prevailing in Europe and the United States. Accordingly, we believe that there is an
opportunity for us to grow correspondingly with the general growth of the
supermarket sector in Israel.

The
food retailing industry has been subject to increased competition in recent
years. In addition, as a result of
consumers increased focus on the price of products, we and other major chains
have expanded our low-priced store formats and, during 2005, other major chains
have expanded into hard discount store formats. Also, very low-priced private supermarkets
have expanded their presence in selected areas. The increased competition has led to increased downward pressure
on prices. As a result of the change in
the business environment and these developments, we relocated some of our
stores and closed four underperforming stores in 2004. However, we opened seven new stores to
compete in selective areas in which we did not believe we had sufficient market
presence.

49

---

---



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.

During
previous years, we continued our adjustment to meet the needs of more price-sensitive customers. As a result, we have
emphasized our Mega
supermarket format, a chain of discount stores. During 2004, we converted four supermarkets of other formats to
Megas and opened three new Mega stores. During 2003, we expanded a new supermarket chain called Shefa
Shuk. Shefa Shuk 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.
During 2004, we converted 17 Super Center and King Center supermarkets into
Shefa Shuk stores.

In
2004, we increased our emphasis on increasing our sales, partially in
anticipation of an improving Israeli economy.
In 2005, we expect to continue our emphasis on increasing our sales.
This may include increasing our marketing activities and lowering our
prices. The investment required to
carry out this program is likely to increase our expenses and reduce our
margins in the short term. However, we
believe it will pay off over the long term.

In
addition, we completed the process of streamlining our store brands to just
three  Mega, Super Center and Shefa Shuk - from our previous seven brands.
Although the investment required to carry out this program is likely to reduce our
margins in the short term, we believe that we will be able to focus our
marketing efforts more effectively with fewer store brands.

In
2005, we are taking action 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 with the goal of increasing the portion of our
customers overall shopping needs that are addressed in our stores. To this
end, we recently 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. We currently plan to open
approximately 40 All for a Dollar and toy departments in our stores in order
to expand our offering of houseware goods. In addition, we have applied for
licenses to sell over the counter pharmaceutical medical products (OTC drugs)
to further expand the mix of goods sold in our stores. Some of our license applications have
already been approved.

Some
of our largest suppliers have completed a series of consolidations, while the
trend of consolidation among our suppliers may continue. These suppliers may
attempt to leverage their negotiating power as their size and market share
grow.

50

---

---



E.
        Off-Balance Sheet
Arrangements. None

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

51

---

---



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

A.       Directors
and Senior Management.

The
following table lists the name, age and position of the directors and executive
officers of Blue Square as of June 15, 2005.

|                             |     |                                                              
|---------------------------- | --- | -------------------------------------------------------------
|Name                         | Age | Position                                                     
|                             |     |                                                              
|                             |     |                                                              
|Matthew
  Bronfman (1)       | 45  | Chairman
  of the Board of Directors                         
|David
  Wiessman (1)         | 50  | Vice
  Chairman and Acting Chairman of the Board of Directors
|Yitzhak
  Bader              | 59  | Director                                                     
|Yaakov
  Shalom Fisher       | 48  | Director                                                     
|Pinchas
  Cohen              | 54  | Director                                                     
|Shlomo
  Zohar               | 53  | Director                                                     
|Avraham
  Meron              | 65  | Director                                                     
|Davidi
  Marom               | 52  | Director                                                     
|Shlomo
  Even (2)            | 48  | Director                                                     
|Ron
  Hadassi (2)            | 40  | Director                                                     
|Merav
  Gold                 | 41  | Director                                                     
|Elisha
  Eitani              | 56  | Director                                                     
|David
  Wainshal (1) (2) (3) | 69  | Director                                                     
|Zeev
  Vurembrand (2) (3)    | 54  | Director                                                     
|Gil
  Unger                  | 51  | President
  and Chief Executive Officer                      
|Emanuel
  Avner              | 44  | Vice
  President and Chief Financial Officer                 
|Uri
  Falach                 | 48  | Vice
  President for Trade                                   
|Michael
  (Miki) Lev         | 54  | Vice
  President for Operations                              
|Sandrine
  Montsma           | 36  | Vice
  President for Marketing                               
|Ilan
  Buchris               | 53  | Head
  of Planning and Maintenance Division                  
|Moshe
  Shatz                | 57  | Head
  of Human Resources Division                           
|Oren
  Lahat                 | 57  | Head
  of Real Estate Development Division                   
|Odelia
  Levanon             | 42  | Head
  of Information Technology Division                    
|Iris Penso                   | 44  | General
  Counsel and Corporate Secretary                    
|Shay
  Lifshitz              | 51  | Head
  of Trade Headquarters                                 

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

Matthew
Bronfman has served as the chairman of our board of
directors from June 2003. Mr. Bronfman
is currently managing director of ACI Capital American Fund, is Deputy and Vice
Chairman of the Board of Bronfman-Alon, Deputy and Vice Chairman of the Board
of BSIP and is on the board of directors of Tweeter  Home Entertainment Group
(TWTR). Mr. Bronfman is a member of the Compensation Committee of Blue
Square. Effective as of June 1, 2005,
Mr. Bronfman, through an entity that he indirectly controls, acquired 100% of a
company that holds the concession to IKEA in Israel. In addition, on February 1, 2005, a group of investors led by Mr.
Bronfman entered into an agreement to acquire the controlling interest in Israel Discount Bank
Ltd. The transaction is subject to
final approval by international and local regulatory authorities.

52

---

---



David
Wiessman has served as Vice Chairman and
Acting Chairman of our board of directors from June 2003. Mr. Wiessman is currently the
Chairman of the Board of directors of BSIP. In addition, Mr. Wiessman is currently the
President and Chief Executive Officer of Alon Israel Oil Company Ltd. and President and
Executive Chairman of Dor Alon Energy In Israel (1988) Ltd., Chief Executive Officer of
Bielsol Investments (1987) Ltd., Chairman of the Board of Bronfman-Alon, Excutive Chairman
of Alon U.S.A. Energy, Inc. and holds director and/or officer positions in other companies
affiliated with the foregoing Alon entities, both in Israel and the United States. Mr.
Wiessman is a member of the Compensation Committee of Blue Square.

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 Bronfman-Alon,
BSIP, Dor Gas Ltd., Dor Alon Operating Service Stations Ltd., Dor Alon Gas
Technologies Ltd., Alon USA Energy, Inc., Alon USA Operating, Inc., Alon USA
GP, LLC, Alon USA Capital Inc., Alon Assets Inc., ALON USA INC., Pri-Gat Ltd.,
entities under control of Granot, and One Technologies Software (ASD) Ltd.

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

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

Shlomo
Zoharhas served as our director since March 8, 2004,
and he is also currently a director of BSIP and of Blue Square Furniture Ltd.
(the company that holds the Israeli franchise to IKEA in Israel; currently
unrelated to the Company), and an observer on the board of directors of Israel
Discount Bank Ltd (appointed by the group of investors that have agreed to
acquire the controlling interest in Israel Discount Bank Ltd.) Mr. Shlomo Zohar is a certified C.P.A. in
Israel and has served for the last 26 years as C.P.A at Zohar, Zohar &
Co. Mr. Zohar holds a B.A degree in
Accounting and Business Administration from Bar-Ilan University and M.B.A. in
Business Administration from McGill University in Canada. Mr. Zohar specified
in the last years in the area of mergers & acquisitions in Israel and
abroad.

53

---

---



Avraham
Meron has served as our director from June 2003. Mr. Meron is currently Chief Financial
Officer of Africa Israel Investments Ltd., and a director of subsidiaries and
affiliates of Africa Israel Investment Group Ltd., Alon Israel Oil Company
Ltd., Dor Alon Energy In Israel (1988) Ltd., Alon Dor Operating Service
Stations Ltd and other companies of Dor Alon Group and Alon U.S.A. Energy.

Davidi
Marom has served as our director since June 2003. Mr. Marom is currently CEO of Diklaim Ltd.
(one of the Companys food suppliers) and a director of Hamashbir Hamerkazi
Cooperative Society for Supply Ltd. and Hamagen Pension Fund.

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

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

Merav
Goldhas served as our director since June 2003, and
she is also currently a director of BSIP. Ms. Gold is currently Chief Executive
Officer of Palace Candles Inc., a director in Bronfman-Alon and Vita Pri-Galil
Ltd, an external director of Liberties Properties Ltd.

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

David
Wainshalhas served as our external director since
January 6, 2004. David Wainshal is
currently a private businessman and the Chairman of the Public Committee for
the Shares of Bank Leumi LYisrael Ltd. From 1998 to 2001, Mr. Wainshal was the
Chairman of the Board of Migdal Insurance Company, from 1991 to 1997, Mr.
Wainshal was the Chief Executive Officer of Clal Israel, and from 1981 to 1991,
he was the Chief Executive Officer of Super Sol. Mr. Wainshal holds a B.A. in
economics from Hebrew University and an M.A. in social science from the
Institute of Social Studies in Hague, Holland. Mr. Wainshal is a member of the
Audit Committee of Blue Square.

54

---

---



Zeev
Vurembrandhas served as our external director since
February 2001. In October, 2002, Mr. Vurembrand was appointed Chief
Executive Officer of Clalit Health Services, the leading health care
institution in Israel, which provides comprehensive medical care to 3.7 million
members, some 60% of the Israeli population. Mr. Vurembrand also holds
the position of Chairman of the Board of Directors of the Mor Institute for
Medical Data Ltd., Clalit Bio-Medical Engineering Ltd., and Shilah Dental
Services, all Clalit Health Services subsidiaries. From 1995 until his new
appointment, Mr. Vurembrand served as Deputy Director General and Head of the
Finance and Health Insurance Division of Clalit Health Services (formerly Kupat
Holim Clalit) as well as the Head of Clalit Mushlam.From 1993 to 1995, Mr. Vurembrand served as
the Deputy Director General of Finance and Business Development of Shekem
Ltd., a retail stores chain.    Mr. Vurembrand holds a degree in
Industrial Engineering and Management from the Technion-Israel Institute of
Technology, in Haifa, Israel. Mr. Vurembrand is a member of the Audit Committee
of Blue Square.

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

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

Uri
Falach has served as our Vice President for Trade as
of December 15, 2003. Mr. Falach holds
an MBA degree in Business Administration. From 1994 until today Mr. Falach
served as manager of the agricultural production and was responsible for all
the chain of supply of the agricultural production to Blue Squares Stores.

Michael
(Miki) Lev has served as our Vice President for
Operations, as of November 2, 2003.
From January 1997 until November 2003, Mr. Lev served as head of the
Human Resources and Quality Division of Blue Square. From 1994 to 1996, Mr. Lev
served as the director general of the Lahav School of Management at the
Recanati School of Business Administration in Tel-Aviv University. From 1992 to
1994, Mr. Lev served as a Management Consultant in the Private and Public
Sectors. Mr. Lev, Colonel (retired) in the Israeli Air Force, holds a MSc
degree in Administration from Naval Post-Graduate School, Monterey, California,
USA.

55

---

---



Sandrine
Montsma has served as our Vice President for Marketing
since June 1, 2004. From January 2003
to March 2004, Mrs. Montsma served as Vice President Marketing, Strategy and
New Business of Elite Industries Ltd, Israel. Previously she served as head of
the Bakery Division of Elite Confectionary and later served as the General
Manager of Elite Bakery in Israel. From 1994-1999 Mrs. Montsma served in
several positions in Proctor & Gamble AG, Geneve, Switzerland, such as the
head of Brand Equity Team of Pringles Europe and Head of Category of Hair Care
Israel. Mrs. Montsma graduated with
distinction the M.B.A. Programme of Insead, Fontainebleau in France and holds a
B.A. degree (1st Class Honours) in Economics & Business Administration from
the Hebrew University in Israel.

Ilan
Buchrishas served as our Head of Planning and
Maintenance Division, as of November 18, 2004. Mr. Buchris, Colonel (retired)
in the Israeli Navy, holds a M.A. Degree in political science from Haifa University
and a B.A. Degree in settlement geography from Bar Ilan University. Between
2000-2004 Mr. Buchris served as Authorities Coordinator at Derech Eretz
Highways (1997) Ltd.

Moshe
Shatz has served as our head of the Human Resources
Division as of November 17, 2003. Mr. Shatz replaces Mr. Michael (Miki)
Lev. 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 16, 2004.
Prior to that, he served from 1992-2003 as Head of the Stations Development
Division and a member of the managing team of Sonol Israel Ltd.

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

Iris
Penso, Adv. has served as our general counsel and
corporate secretary since October 2001. Mrs. Penso is serving as head of the
Legal Department and as General Counsel and Corporate Secretary of various Blue
Square subsidiaries. From 2000 to 2001, Mrs. Penso served as General Legal
Counsel and Corporate Secretary and Assistant Director General to the President
and Chief Executive Officer of Ace Marketing Chains Consumer Products Ltd. From 1997 to 2000, Mrs. Penso served as
General Legal Counsel and Corporate Secretary and Management Member of Tempo
Beer Industries Ltd., and its subsidiaries. Mrs. Penso has an LLB from Tel Aviv
University.

56

---

---



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.

Termination of Office

David
Brodet served as a director until December 2004, Yoram Dar served as our President and Chief
Executive Officer until February 10, 2004, and Avi Belfer served as Head of the Planning and Maintenance
Division until September 24, 2004.

Arrangements for the Election of Directors

Bronfman 
Alon owns approximately 77.38% of our ordinary shares following the conversion
by other investors of an aggregate of approximately NIS 13.8 million in
principal amount of our 5.9% convertible debentures since their issuance in
August 2003. So long as BronfmanAlon
continues to own beneficially more than 50% of our outstanding ordinary shares
and voting power, it will be able to control the outcome of matters requiring
shareholder approval, including the election of all Blue Square directors,
other than Blue Square two external directors whose election, under the Israeli
companies law, requires that at least one-third of the non-controlling
shareholders who participate in the vote, vote for their nomination, or that the
total number of shares of non-controlling shareholders voted against their
nomination does not exceed one percent of the aggregate voting rights in the
company.

B.        Compensation.

The
following table sets forth the aggregate compensation we paid or accrued on
behalf of all persons who served as Blue Square directors or executive officers
for services they rendered Blue Square, for the year ended December 31,
2004. 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, retirementand similar benefits |  
|                                                                   |  |                                                                     |           |                                         |  
|                                                                   |  |                                                                     |           |                                         |   |         | 
|All
  directors, executive officers and Acting Chairman as a group |  | $                                                                   | 4,472,000 |                                         | $ | 520,000 | 

We
agreed to pay to each director (including our external directors), other than
the Chairman and the vice Chairman of the Board of Directors, the sum of NIS
45,392 per year and a meeting attendance fee of NIS 1,746, 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.

57

---

---



We also
agreed to pay our chairman, Matthew Bronfman a monthly payment of NIS 42,000
plus VAT commencing from June 24, 2003, the date Mr. Bronfman became Blue
Square Chairman of the Board. The compensation would be linked to changes in
Israels CPI since May 2003, and would be updated every three months. No
additional fees would be paid to Mr. Bronfman for attending meetings of the
Board of Directors or any committee of the Board of Directors. Mr. Bronfman
would also be entitled to reimbursement of actual expenses (upon submission of
receipts) incurred by him in connection with his service as the Chairman of the
Board of up to $50,000 per year. Our
audit committee, board of directors and shareholders meeting approved this
arrangement.

BSIP also
agreed to pay David Wiessman, our Vice Chairman and Acting Chairman, in his
capacity as BSIPs Chairman of the Board of Directors, a monthly payment of NIS
42,000 plus VAT commencing from June 24, 2003, the date Mr. Wiessman became
BSIPs Chairman of the Board. The
compensation would be linked to changes in Israels CPI since May 2003, and
would be 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 would also be entitled to reimbursement of
actual expenses (upon submission of receipts) incurred by him in connection
with his service as Chairman of the Board of BSIP. Our audit committee, board of directors and shareholders meeting
approved this arrangement. These
amounts are paid to Mr. Wiessman by BSIP.

C.        Board
Practices

Appointment of Directors and Terms of
Officers

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

58

---

---



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

Substitute Directors

Our
Articles of Association provide that any director may appoint another person to
serve as a substitute director and may cancel such appointment. The identity of
a substitute director requires the approval of the board of directors. Under
the Israeli Companies Law, there shall not be appointed as a substitute
director, any person who is not himself qualified to be appointed as a director
or a person who is already serving as a director or a person who is already
serving as a substitute director for another director. Nevertheless, a director
may be appointed as a substitute director for a committee of the board of
directors if (s)he is not already serving as a member of the committee. Under
the Israeli Companies Law, there shall not be appointed a substitute director
for an external director.

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

Independent and External Directors

Israeli Companies Law Requirements

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

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

|  |                                                                                                                                                                                                             
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | an
  employment relationship;                                                                                                                                                                               
|  |                                                                                                                                                                                                             
| | a business
  or professional relationship maintained on a regular basis;                                                                                                                                    
|  |                                                                                                                                                                                                             
| | 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.

59

---

---



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.
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
Directors are required to have professional expertise. These requirements are
subject to regulations to be promulgated in which the terms financial and
accounting expertise and professional expertise would be defined. This
recent amendment does not apply to External Directors who were appointed prior
to March 17, 2005 (such as our current External Directors).

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

The
initial term of an external director is three years and may be extended for an
additional three years. External directors may be removed only in a
general meeting, by the same percentage of shareholders as is required for
their election, or by a court, and in both cases only if the external directors cease to meet the statutory
qualifications for their appointment or if they violate their duty of loyalty
to us. Each committee of our board of directors is required to
include at least one external director and its audit committee is required to
include all of the external directors.

David
Wainshal and Zeev Vurembrand currently serve as our external directors.

New
York Stock Exchange Requirements

Our
ADSs are listed on the New York Stock Exchange, and we are subject to the rules
of the NYSE applicable to listed companies.
Under the current NYSE rules, we are required to have an audit committee
consisting of at least three directors, all of who must be independent. The independence standard under the NYSE
rules generally excludes (1) any person who is an employee of a company or its
affiliates or any person who is an immediate family member of an executive
officer of a company or its affiliates, until the lapse of three years from the
termination of such employment, (2) any person who is a partner, controlling
shareholder or executive officer of an organization that has a business
relationship with us or who has direct business relationship with a company,
unless the board of directors of us determines that the business relationship
does not interfere with such persons independent judgment, or unless three
years have lapsed from the termination of such relationship or his status as a
partner, controlling shareholder or executive officer, and (3) any person who
is employed as an executive of another corporation where any of our executives
serves on that corporations compensation committee. See  - Audit Committees -
New York Stock Exchange Requirements for a description of the NYSE rules that
become effective with respect to Blue Square on July 31, 2005.

60

---

---



Audit Committees

Israeli Companies Law Requirements

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

|  |                                                                              
|- | -----------------------------------------------------------------------------
| | chairman of
  the board of directors;                                        
|  |                                                                              
| | controlling
  shareholder or his relative; and                               
|  |                                                                              
| | any director
  employed by or who provides services to us on a regular basis.

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

An
interested party is defined in the Israeli Companies Law as a 5% or greater
shareholder, any person or entity who has the right to designate one director
or more or the general manager of ours or any person who serves as a director
or as a general manager.

An
audit committee may not approve an action or a transaction with an interested
party unless at the time of approval the two external directors are serving as
members of the audit committee and at least one of whom was present at the
meeting in which an approval was granted.

New
York Stock Exchange Requirements

Under
the current New York Stock Exchange rules, Blue Square is required to maintain
an audit committee consisting of independent directors, all of whom are
financially literate and one of whom has accounting or related financial
management expertise. Blue Squares
audit committee complies with these requirements. The responsibilities of the audit committee under New York Stock
Exchange rules include evaluating the independence of a companys outside
auditors.

61

---

---



Pursuant to
the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission (the
SEC) issued new rules which, among other things, require the New York Stock
Exchange to impose independence requirements on each member of the audit
committee. The New York Stock Exchange adopted rules that comply with the SECs
requirements and become effective with respect to Blue Square on July 31, 2005.

The
requirements implement two basic criteria for determining independence: (i)
audit committee members would be barred from accepting any consulting, advisory
or other compensatory fee from the issuer or an affiliate of the issuer, other
than in the members capacity as a member of the board of directors and any
board committee, and (ii) audit committee members of an issuer that is not an
investment company may not be an affiliated person of the issuer or any
subsidiary of the issuer apart from his or her capacity as a member of the
board and any board committee.

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

As
of June 15, 2005, David Wainshal, Zeev Vurembrand, Shlomo Even and Ron Hadassi
served as members of our audit committee.

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

Internal Auditor

Under
the Israeli Companies Law, the board of directors must also appoint an internal
auditor proposed by the audit committee.
The role of the internal auditor is to examine whether our actions
comply with the law, integrity and orderly business procedure. Under the Israeli Companies Law, the
internal auditor may not be an interested party, an office holder, or a relative
of an interested party, an office holder or an interested party, nor may the
internal auditor be our independent accountant or its representative. We comply with this requirement. Effective January
1, 2005, Ronit Zilberfarb
was our internal auditor.

62

---

---



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

Fiduciary
Duties of Office Holders

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

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

|  |                                                                                                                                     
|- | ------------------------------------------------------------------------------------------------------------------------------------
| | information
  on the appropriateness of a given action brought for his approval or
  performed by him by virtue of his position; and
|  |                                                                                                                                     
| | all other
  important information pertaining to the previous actions.                                                               

The duty of
loyalty of an office holder includes a duty to:

|  |                                                                                                                                                                       
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | refrain from
  any conflict of interest between the performance of his duties in the company
  and his personal affairs;                                              
|  |                                                                                                                                                                       
| | refrain from
  any activity that is competitive with the company;                                                                                                     
|  |                                                                                                                                                                       
| | refrain from
  usurping any business opportunity of the company to receive a personal gain
  for himself or others; and                                               
|  |                                                                                                                                                                       
| | disclose to
  the company any information or documents relating to a companys affairs
  which the office holder has received due to his position as an office holder.

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

The
Israeli Companies Law requires that an office holder of a company promptly
disclose any personal interest that he may have and all related material
information known to him, in connection with any existing or proposed
transaction by the company. A personal
interest of an office holder includes an interest of a company in which the
office holder is, directly or indirectly, a 5% or greater shareholder, director
or general manager, or in which he or she has the right to appoint at least one
director or the general manager. In the
case of an extraordinary transaction, the office holders duty to disclose
applies also to a personal interest of the office holders relative. The office holder must also disclose any
personal interest held by the office holders spouse, siblings, parents,
grandparents, descendants, spouses descendants and the spouses of any of the
foregoing.

Under
Israeli law, an extraordinary transaction is a transaction:

|  |                                                 
|- | ------------------------------------------------
| | other than
  in the ordinary course of business;

63

---

---



|  |                                                                                                    
|- | ---------------------------------------------------------------------------------------------------
| | other than
  on market terms; or                                                                   
|  |                                                                                                    
| | that is
  likely to have a material impact on the companys profitability, assets or
  liabilities.

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

If
the transaction is an extraordinary transaction, both the audit committee and
the board of directors must approve the transaction. Under specific circumstances, shareholders approval may also be
required. An office holder who has a
personal interest in a matter, which is considered at a meeting of the board of
directors or the audit committee, may not be present at this meeting or vote on
this matter. If most of the directors have a personal interest in a
matter, a director who has the personal interest in this matter may be present
at this meeting or vote on this matter, but the board of directors decision
requires the shareholder approval.

Controlling
Shareholder Transactions and Actions

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

|  |                                                                                                                                                                                                    
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | at least
  one-third of the shareholders who have no personal interest in the
  transaction and who are participating in the voting, in person, by proxy or
  by written ballot, at the meeting; or
|  |                                                                                                                                                                                                    
| | The total
  number of shares voted against the
  proposal by shareholders without a personal interest does not exceed one
  percent (1%) of the aggregate voting rights in the Company.            

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

64

---

---



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) do not
require shareholder approval.

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

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

Exemption, Insurance and Indemnification of
Directors and Officers

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

65

---

---



Office
Holder Insurance

The
Israeli Companies Law and our Articles of Association provide that, subject to
the provisions of the Israeli Companies Law, we may enter into a contract for
the insurance of the liability of any of our office holders with respect to:

|  |                                                                                                                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a breach of
  his duty of care to Blue Square or to another person;                                                                                                                                      
|  |                                                                                                                                                                                                          
| | a breach of
  his duty of loyalty to Blue Square, provided that the office holder acted in
  good faith and had reasonable cause to assume that his act would not
  prejudice Blue Squares interests; or
|  |                                                                                                                                                                                                          
| | a financial
  liability imposed upon him in favor of another person concerning an act
  performed by him in his capacity as an office holder.                                                            
|  |                                                                                                                                                                                                          
| | a breach of
  any duty or any other obligation, to the extent insurance may be permitting
  by law.                                                                                                      

Exemption and Indemnification of
Office Holders

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

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i) a
  monetary liability imposed on him in favor of another person pursuant to a
  judgment, including a judgment given in a settlement or an arbitrators award
  approved by the court concerning an act performed in his capacity as an
  office holder; and                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | (ii)
  reasonable litigation expenses, including counsel fees, incurred by an office
  holder or a former office holder or which he is ordered to pay by a court, in
  proceedings Blue Square institutes against him or instituted on Blue Square
  behalf or by another person, or in a criminal charge from which he was
  acquitted, or a criminal charge in which he was convicted for a criminal
  offense that does not require proof of intent, in each case relating to an
  act performed in his capacity as an office holder.

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

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

66

---

---



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.

The
Company has not yet amended its Articles of Association to reflect this recent
change to the Israeli Companies Law.

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

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

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

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a provision authorizing the company to indemnify an Office Holder for
  future events with respect to a monetary liability imposed on him in favor of
  another person pursuant to a judgment (including a judgment given in a
  settlement or an arbitrators award approved by the court), as described in
  clause (i) under -Exemption and Indemnification of Office Holders above, so
  long as such indemnification is limited to types of events which, in the
  Boards opinion, are foreseeable at the time of granting the indemnity
  undertaking in view of the Companys actual business, and in such amount or
  standard as the Board deems reasonable under the circumstances. Such undertaking must specify the events
  that in the Boards opinion are foreseeable in view of the Companys actual
  business at the time of the undertaking and the amount or the standards that
  the Board deemed reasonable at the time;
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | a provision to undertake to indemnify for future events as set forth
  with respect to litigation expenses described in clause (ii) under -
  Exemption and Indemnification of Office Holders and in the first paragraph
  under - Exemption and Indemnification of Office Holders  Recent Changes to
  Israeli Companies Law; or                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | a provision
  authorizing the company to retroactively indemnify an Office Holder.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

67

---

---



The
Company has not yet amended its Articles of Association to reflect these recent
changes to the Israeli Companies Law.

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;                                                               
|  |                                                                                                                                                                                                                                                           
| | 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;

68

---

---



|  |                                                                                                                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | An action,
  including handing over information and papers, in connection with sale of our
  shares or assets, by the Co-Op;                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                 
| | The filing
  of a report or announcement required by the Israeli Companies Law or the
  Israeli Securities Law, 1968, the rules and regulations of a stock exchange
  in or outside Israel, or any law of any other country pertaining to these
  issues, and/or omission to file such a report or announcement;
|  |                                                                                                                                                                                                                                                                                                                 
| | Any change
  of reorganization of us, including any related decision, including without
  limiting the generality of the foregoing, splitting, dividing or modifying
  our share capital, establishment of subsidiaries or their liquidation or sale
  and issuance of shares;                                  
|  |                                                                                                                                                                                                                                                                                                                 
| | Oral or
  written statements, including the expression of an opinion or a position
  conveyed in good faith by an office holder, in his capacity as such, during
  his term of office, including statements made in meetings of the board of
  directors or any committee;                                      
|  |                                                                                                                                                                                                                                                                                                                 
| | An action in
  the line of business of us in relation with the following issues: building
  and planning, licensing of businesses, safety in work places, environment and
  recycling and protection of the consumer; or                                                                                        
|  |                                                                                                                                                                                                                                                                                                                 
| | Each one of
  the circumstances stated above, all in connection with the officeholders
  service on behalf of our subsidiaries or affiliated companies.                                                                                                                                                        

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

We
agreed to indemnify our directors and officers to the fullest extent
permissible by the Israeli Companies Law, against all amounts they may be
obligated to pay as a result of a court decision or a settlement or an
arbitrator ruling 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.

69

---

---



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

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

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

|   |                                                                                                                                                                       
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | A breach of fiduciary duty, which was acted not in good faith or that
  the officer had reasonable grounds to believe that the act would cause the
  company any harm;
|   |                                                                                                                                                                       
|2. | A violation of the duty of care, which was committed intentionally or
  recklessly;                                                                                   
|   |                                                                                                                                                                       
|3. | An act committed with the intention to realize a personal illegal
  profit; or                                                                                        
|   |                                                                                                                                                                       
|4. | A fine or monetary composition imposed on him.                                                                                                                        

Under
the resolution from February 2001, we obtained and will continue to hold a
directors and officers liability insurance policy. Coverage under our policy has been set at $30 million (including
its subsidiaries). We have purchased directors and officers liability
insurance policy for our directors and officers and those of our subsidiaries,
which includes BSIP and its
subsidiaries. The Insurance Policy is for a period beginning on November 1,
2004, and ending on October 31, 2005, for the maximum coverage of US$30 million
per claim and in the aggregate during the Policy Period. Our audit committee, Board of Directors and
shareholders have approved any renewal and/or extension of the Insurance Policy
and the purchase of any other insurance policy, provided that any such renewal,
extension or purchase is for the benefit of Blue Squares previous and/or
current and/or future directors and officers and on terms substantially similar
to those of the Insurance Policy and on condition that the premium will not
increase by more than 25% in any year, as compared to the previous year. Our current insurance policies comply with
these terms.

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

70

---

---



Committees

Our
board of directors has established a compensation committee and an audit
committee. Our compensation committee,
which consists of Matthew Bronfman, David Wiessman and David Wainshal,
administers issues relating to employee compensation for senior
management. Our audit committee, which
consists of Zeev Vurembrand, David Wainshal, Shlomo Even and Ron Hadassi,
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.

D.        Employees.

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

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

As
of December 31, 2002, we employed 7,200 employees, counting multiple
employees sharing a single position as a single employee. 767 of our employees were employed in
central management and administration and in our logistics center and 6,433 in
our stores.

On
November 5, 2003, pursuant to our agreement with the Histadrut (General
Federation of Labor in Israel) (Histadrut), we announced the dismissal of
approximately 100 employees from our headquarter staff and another 150 store
employees. In addition, during 2004, we
dismissed approximately 30 people from the Planning and Maintenance Division.
We are subject to labor laws and regulations in Israel. Most of our employees are subject to
collective bargaining labor agreements. Under a Special Collective Bargaining
Agreement, referred to as the Special Agreement, from May 1996, among the
Co-Op, Blue Square, the Histadrut, the National Committee of the Co-Op Union
Employees and the Co-Op Union, all the Co-Op employees became employees of Blue
Square. The collective bargaining
agreements in effect as of that date apply to Blue Square as if Blue Square and
these employees were originally parties to these agreements. Blue Square became responsible for the
payment of all employee benefits that had been accrued in respect of these
employees during the term of employment of these employees with the Co-Op, to
the extent these benefits were recorded on the Co-Ops records. Since 1996, we entered into new labor
agreements with the Histadrut and the Co-Op union, which determines our
employees wages structure, the employment conditions of new employees and a
wage increase to the existing employees.

71

---

---



During
2003, we agreed to make good will grants to management and employees. In
respect of grants to our employees, we entered into a collective bargaining
arrangement with the Histadrut and
the National Committee of the Co-Op Blue Square Employees in August 2003. Under that agreement, we agreed (i) to grant
to our permanent employees a good will grant of NIS 37.5 million in the
aggregate in two installments, the first of which in August 2003 and the second
in April 2004; (ii) to grant NIS 2 million to employees allocated in the manner
determined by our chairman and the chairman of an employees committee; (iii) to grant an additional NIS 1 million
to our temporary employees; (iv) to pay to our permanent employees 1% of any
cash dividend distributed to our shareholders, but not more than $2.5 million
in the aggregate to our employees; and (v) in any public issuance of our shares
after the date of the agreement, our permanent employees will be entitled to
purchase up to 10% of any such offering with a 20% discount over the minimum
offering price (in the event that convertible securities will be
offered, the employees will be entitled to a discount of 20% from the exercise
price or the rate of conversion; in the event shares are offered to the public
together with other securities, employees will be entitled to a discount of 20%
only on the offering price of the shares). With respect to such a
purchase by our employees of our shares in a public offering, we have agreed to
make loans to our employees to enable them to pay the purchase price for the
shares, and these loans are to be repaid by the employees with interest and linkage
upon the sale of the shares following the expiration of the appropriate tax
holding period for the shares or, if desired by the employee, until the earlier
of five years from the expiration of the holding period or the end of the
employees employment with us.

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

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

In
January 2005, we entered into a special collective bargaining arrangement with 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.

72

---

---



In
addition, we and our employees are also subject to certain provisions of the
general collective bargaining agreements between the Histadrut and the
Coordination Bureau of Economic Organizations (including the Industrialists
Association) by virtue of an extension order of the Israeli Ministry of Labor. These agreements concern, among other
things, the maximum length of the work day and the work week, contributions to
a pension fund, insurance for work-related accidents, procedures for dismissing
employees, determination of severance pay and other conditions of employment.

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

E.        Share
Ownership.

As
of June 15, 2005, other than indirect ownership through Bronfman  Alon, none
of our directors or officers owned more than 1% of our outstanding equity
securities.

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

A.        Major
Shareholders.

The
following table sets forth certain information regarding the beneficial
ownership of our ordinary shares as of June 29, 2005, 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
OrdinaryShares
  Beneficially
  Owned |  | Percentage
  of
  Outstanding Ordinary
  Shares(1) | 
|                   |  |                                                 |  |                                                    |  |  | 
|Bronfman  Alon(2) |  |                                                 |  | 30,008,399                                         |  |  |  |  | 77.38 | % | 



---

|    |                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------
|(1) | The
  percentage of outstanding ordinary shares is based on 38,782,336 ordinary
  shares outstanding as of June
  29, 2005.

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

73

---

---



As
of June 9, 2005, Blue Square had approximately 45 shareholders of record with a
United States address. As of June 9,
2005, these United States record holders held approximately 931,144 ordinary
shares in the form of ADSs, representing approximately 2.4 % of our then outstanding
share capital.

BronfmanAlon
acquired a 78.1% interest in Blue Square from the Co-Op in June, 2003. Bronfman-Alons percentage interest in Blue
Square has been reduced to 77.38% due to the conversion by other investors of
an aggregate of approximately NIS 13.8 million in principal amount of our 5.9%
convertible debentures since their issuance in August 2003.

To
the Companys best knowledge, BronfmanAlon is a wholly owned subsidiary of
Nissan Alon Retail Holdings Ltd., which is a wholly owned subsidiary of the
Nissan Dor Chains Ltd. (Grandparent Company). Dor Food Chains Holdings Ltd. (Dor Food) holds
50% of the
equity interest of the Grandparent Company, and the other 50% of the equity
interest is held by M.B.I.S.F. Holdings Ltd. (M.S.). Dor Food is a wholly
owned subsidiary of Alon-Israel Oil Company Ltd. (Alon). To the Companys best knowledge, Alon is
owned approximately 34.65% by nine collective acquisition entities of kibbutzim in
Israel, approximately 26.14% by Africa Israel Trade and Agencies Ltd., a
subsidiary of Africa Israel Investments Ltd., a public company traded on the
Tel Aviv Stock Exchange, and approximately 39.21% are held together by Bielsol
Investments (1987) Ltd. and Mr. David Wiessman. To the Companys best knowledge,
Mr. Lev Leveiv is the controlling shareholder of Africa Israel. To the Companys best knowledge, Bielsol
Investments (1987) Ltd. is controlled by David Wiessman and the family of
Advocate Biran.

To
the Companys best knowledge, M.S. is a wholly owned subsidiary of
Bronfman-Fisher Investments Ltd. (Bronfman-Fisher), Matthew Bronfman owns
approximately 51% of the equity of Bronfman-Fisher, the Bronfman Family Trusts
own approximately 5.5% and Yaakov Shalom Fisher owns the remaining 43.5% of the
equity.

B.        Related
Party Transactions.

Procurement
Agreement with Dor Alon Stations

Dor
Alon Operating Service Station Ltd., a subsidiary of Dor-Alon Gas Station
Operation Ltd (a fully 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 pay to 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. Under the terms of the Procurement
Agreement, we and Dor Alon Stations will share certain expenses relating to
computerization, which include a one-time expense for converting programs,
currently estimated to be NIS 1.2 million; the final amount of the expense will
be agreed upon between the parties. The
parties will also share the cost of annual maintenance for the computer system
that the parties currently estimate to be 17% of the one-time expense; the
final amount for the maintenance expense will also be agreed upon between the
parties.

74

---

---



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

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

Consulting
Agreement with Shlomo Zohar

We
are a party to a consulting agreement with S. Zohar Consulting and Management
Ltd. (S. Zohar), an entity controlled by Shlomo Zohar, one of our directors, as
an independent contractor to provide us, our subsidiaries and/or our affiliated
companies accounting consulting services in various areas, including accounting
consulting to our management group, tax planning and advice, due diligence,
accounting analyses, internal accounting control over our activities and
transactions, accounting implications for recovery plans, accounting advice
with respect to the issuance of debentures and the like. S. Zohar provides the
services through Shlomo Zohar, CPA. The
services provided under the consulting agreement through Mr. Shlomo Zohar are
unrelated to the services provided by Mr. Shlomo Zohar to us in his capacity as
a director.

75

---

---



In
consideration for the services, we pay S. Zohar the NIS equivalent of US
$20,000 per month plus VAT.

Either
party has the right to terminate the agreement for any reason upon 60 days
written notice. In the event that S. Zohar does not provide the services
through Shlomo Zohar, we have the right to terminate the agreement immediately.

Management
Agreement with Co-Op

The
Co-Op, our former controlling shareholder, provided us with management and
other services. The service agreement
became effective in April 1996 and expired in June 2003. Under the agreement, the annual fee was
determined to be $1.25 million until 2000 and that the sum would be discussed
between us and the Co-Op commencing with the year 2001. The annual management
fee for 2001 was decreased to $750,000, and the annual management fee for 2002
was decreased to $600,000. For the
period starting January 2003 until expiration in June 2003, we paid the Co-Op $
250,000.

Arrangements
between Blue Square and various subsidiaries

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 3,039 employees are working for Hyper Hyper under that
arrangement as of December 31, 2004. In
consideration for the use of these borrowed employees, Hyper Hyper pays Blue
Square the full amount to be made to, or on account of, these employees
according to the terms of the collective labor agreement between Blue Square
and the Histadrut. Blue Square is
responsible for paying the salaries and other benefits to the borrowed
employees.

Service
and Management Agreements

Blue
Square acts as the exclusive purchaser for Hyper Hyper, purchasing supermarket
goods for which no mark-up is charged to Hyper Hyper. In addition, Blue Square provides Hyper Hyper with storage,
distribution, logistics, maintenance and advertising 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. The fee commencing from January 2002
was 1.95% of Hyper Hypers sales, which amounted to approximately 70.9 million
in 2004.

76

---

---



Blue
Square provides certain services to BSIP pursuant to a management agreement in
consideration for annual management fees of NIS 100,000, or $23,213 linked to
the July 1996 CPI.

Lease
Arrangements

Pursuant
to an arrangement adopted in October 1996, Blue Square purchases real
property which subsidiaries of BSIP identify as appropriate for their use as a
store location. Such BSIP subsidiaries
lease that property from Blue Square. Some of the lease agreement provide for a
fixed annual rent. Most of the leases provide for an annual rent equal to the
highest of:

|  |                                                                    
|- | -------------------------------------------------------------------
| | 9% of the
  amount invested in that store by Blue Square; or       
|  |                                                                    
| | 2% of the
  annual turnover of that store, for discount stores; and
|  |                                                                    
| | 3% of the
  annual turnover of that store, for other stores.       

No BSIP
subsidiary is obligated to lease the property.
In the event a BSIP subsidiary elects not to lease the property, the
property may be used by Blue Square.

Presently, all leased stores to BSIPs subsidiaries are discount stores.

Hyper
Hyper leased from Blue Square and certain of its subsidiaries 24 facilities in
which it operated different formats of supermarkets. The leases were for varying terms, generally for a period of 119
months, but have since expired.

For
real
property that BSIP and Hyper Hyper leases to the Company, some of the leases
provide for an annual rent of 9% of the adjusted costs of the properties or the
properties value, as determined by an appraiser in year 1987, and some of the
leases provide for a fixed annual rent payment of 9% of the adjusted costs of the properties.

Agreements
to Identify Store Locations

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

Blue
Center Agreement

In
2003 the audit committee, the board of directors and the shareholders meeting
of BSIP approved an agreement between BSIPs fully owned subsidiary, Hyper
Hyper, and Blue Square for the joint operation of Blue Center, 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.

77

---

---



Inter-Company
Accounts

We,
BSIP and Hyper Hyper agreed to maintain inter-company accounts for day-to-day
operations which bore interest at a rate equivalent to that charged by banks on
short-term loans, provided that the rate is not lower than the monthly increase
in the CPI. The average rate was 5.5%
in 2004, 8.5% in 2003 and 7.3 % in 2002.

Other Existing Arrangements

Other
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; advertisement and marketing; insurance, including directors and
officers insurance; customers clubs; gift certificates; use of premises; discounts and bonuses
from suppliers and other arrangements relating to day-to-day operation.

Most
of the existing arrangements between the Company and its subsidiaries are based
on long-term arrangements. As a result
of an examination conducted by the Company, it was found that some of these
arrangements need to be renewed, extended and/or approved. The Company intends to secure the required
extensions, required renewals and/or approvals required by the applicable law,
to the extent necessary.

Ordinary
Course Transactions

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

We
are a party to a supply agreement with Palace Candles Inc. (Palace), a
manufacturer and marketer of candles, aluminum disposable and other products,
which is controlled by Yaakov Shalom
Fisher. Mr. Fisher is a director in
Bronfman-Alon, Blue Square and BSIP and owns approximately 43.5% of the equity
in M.B.I.S.F. Holdings Ltd., which
indirectly holds 50% of the equity interest of Bronfman-Alon, our controlling
shareholder. Pursuant to the agreement, we paid to Palace approximately NIS 17
million in 2004 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,
as described below.

C.        Interests
of Experts and Counsel.

Not
applicable.

78

---

---



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

A.        Consolidated
Statements and Other Financial Information.

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

Legal Proceedings

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

On
April 9,
2003, a suit for NIS 320 million was filed against Blue Square, Super Sol Ltd.,
Club Market Marketing Chain Ltd. and Kol Bo Half Price Ltd, together with an
application for the suit to be recognized as a class action. The suit
stipulated that the portion of the suit attributable to us amounts to
approximately NIS 108 million.

The
plaintiff claimed compensation from us and the other supermarket chains for
overcharges that result from the weighing of products in bulk, together with
the packaging materials. According to the plaintiff, the customer was charged
an aggregate amount that including a charge for the packaging materials, which
charge, the plaintiff alleged, is illegal.

In
August 2004, a settlement was reached, according to which the defendants have
committed to take certain measures (deducting the packaging weight in case it
is over 10 gr. or alternatively posting appropriate explanatory signs) as
stipulated in the settlement agreement. In addition, the Company paid the
plaintiff a compensation of approximately NIS 184,000.

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

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

In
November 2001 a claim was filed against Blue Square, the Company for Drink
Containers Collection Corporation Ltd., and other supermarket chains in
connection with fulfillment by these defendants of provisions of the Law for
Deposits on Beverage Containers, 1999 (which became effective on October 1,
2001). The plaintiffs have requested
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. 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.

79

---

---



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

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

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. Please see Item 4. Information on Blue Square - B.
Business
Overview - Government Regulation for information regarding the status of our
negotiations with respect to a consent decree relating to the alleged
restrictive trade arrangements between the major supermarkets chains and the
large suppliers.

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.

80

---

---



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.

Board
Resolution on Dividend Distributions

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

Independent
Accountants

On
January 25, 2005, 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, 2005. Kesselman
& Kesselman has no relationship with us or with any affiliate of us, except
as auditors.

Pursuant
to an agreement among the shareholders of Bronfman-Alon, it was agreed that the
two shareholder groups would each be entitled to request Blue Square to
nominate one firm as our auditors. The
two shareholder groups have agreed on the appointment of Kesselman &
Kesselman as our auditors for the years 2004-2005.

B.        Significant
Changes.

Except
as otherwise disclosed in this annual report, no significant change has
occurred since December 31, 2004.

81

---

---



|        |                      
|------- | ---------------------
|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 |  
| |      |  |      |      |     |   |      | 
| | 2000 |  | $    | 13.9 |     | $ | 9.1  | 
| | 2001 |  | $    | 17.3 |     | $ | 12.5 | 
| | 2002 |  | $    | 17.6 |     | $ | 7.5  | 
| | 2003 |  | $    | 11.5 |     | $ | 6.1  | 
| | 2004 |  | $    | 13.1 |     | $ | 9.3  | 

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 |  
| |                  |  |      |      |     |   |     | 
|
| | 2003             |  |      |      |     |   |     | 
| |                  |  |      |      |     |   |     | 
| | First
  quarter  |  | $    | 8.2  |     | $ | 6.1 | 
| | Second
  quarter |  | $    | 10.1 |     | $ | 7.9 | 
| | Third
  quarter  |  | $    | 10.0 |     | $ | 7.7 | 
| | Fourth
  quarter |  | $    | 11.5 |     | $ | 8.0 | 

| |                  |  |   |      |  |   |      | 
| | ---------------- |  | - | ---- |  | - | ---- | 
| | 2004             |  |   |      |  |   |      | 
| |                  |  |   |      |  |   |      | 
| | First
  quarter  |  | $ | 13.1 |  | $ | 9.7  | 
| | Second
  quarter |  | $ | 11.9 |  | $ | 10.2 | 
| | Third
  quarter  |  | $ | 11.0 |  | $ | 9.7  | 
| | Fourth
  quarter |  | $ | 10.9 |  | $ | 9.3  | 

| |                 |  |   |      |  |   |     | 
| | --------------- |  | - | ---- |  | - | --- | 
| | 2005            |  |   |      |  |   |     | 
| |                 |  |   |      |  |   |     | 
| | First
  quarter |  | $ | 11.0 |  | $ | 9.3 | 

82

---

---



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.

| |          |  |      |      |     |   |     |  |  | 
| | -------- |  | ---- | ---- | --- | - | --- |  |  | 
| | 2004     |  | High |      | Low |  
| |          |  |      |      |     |   |     | 
| |          |  |      |      |     |   |     | 
| | December |  | $    | 10.2 |     | $ | 9.6 | 

| |          |  |   |      |  |   |      |  |  | 
| | -------- |  | - | ---- |  | - | ---- |  |  | 
| | 2005     |  |   |      |  |   |      | 
| |          |  |   |      |  |   |      | 
| | January  |  | $ | 11.0 |  | $ | 10.0 | 
| | February |  | $ | 11.0 |  | $ | 10.2 | 
| | March    |  | $ | 10.9 |  | $ | 9.3  | 
| | April    |  | $ | 9.9  |  | $ | 9.4  | 
| | May      |  | $ | 10.1 |  | $ | 9.5  | 

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 2000, 2001, 2002, 2003 and 2004 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 | 
| |                                        |  |      |      |     |  |      | 
| |                                        |  | NIS  |      | $   |  | NIS  |  | $ |     
| | 2000
  commencing on November 19, 2000 |  |      | 53.4 |     |  | 13.7 |  |   | 48.9 |  |  | 12.1 | 
| | 2001                                   |  |      | 78.5 |     |  | 17.8 |  |   | 51.1 |  |  | 12.2 | 
| | 2002                                   |  |      | 78.8 |     |  | 16.6 |  |   | 35.1 |  |  | 7.4  | 
| | 2003                                   |  |      | 50.2 |     |  | 11.5 |  |   | 29.4 |  |  | 6.7  | 
| | 2004                                   |  |      | 57.8 |     |  | 13.4 |  |   | 40.6 |  |  | 9.4  | 

83

---

---



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.

| |                  |      |  |      |      |  |      |  |  |      |  |  |     |  |  | 
| | ---------------- | ---- |  | ---- | ---- |  | ---- |  |  | ---- |  |  | --- |  |  | 
| |                  | 2003 |  |      | High |  | Low  | 
| |                  |      |  |      |      |  |      | 
| |                  |      |  | NIS  |      |  | $    |  |  | NIS  |  |  | $   | 
| | First Quarter    |      |  | 38.5 |      |  | 8.2  |  |  | 29.4 |  |  | 6.3 | 
| | Second
  quarter |      |  | 44.6 |      |  | 10.4 |  |  | 35.6 |  |  | 8.3 | 
| | Third
  quarter  |      |  | 43.9 |      |  | 9.9  |  |  | 34.4 |  |  | 7.7 | 
| | Fourth
  quarter |      |  | 50.2 |      |  | 11.5 |  |  | 35.0 |  |  | 8.0 | 
| |                  |      |  |      |      |  |      |  |  |      |  |  |     | 

| |                  |      |  |      |      |  |      |  |  |      |  |  |      |  |  | 
| | ---------------- | ---- |  | ---- | ---- |  | ---- |  |  | ---- |  |  | ---- |  |  | 
| |                  | 2004 |  |      | High |  | Low  | 
| |                  |      |  |      |      |  |      | 
| |                  |      |  | NIS  |      |  | $    |  |  | NIS  |  |  | $    | 
| | First
  Quarter  |      |  | 57.8 |      |  | 12.8 |  |  | 44.1 |  |  | 9.7  | 
| | Second
  Quarter |      |  | 52.9 |      |  | 11.8 |  |  | 46.0 |  |  | 10.2 | 
| | Third
  Quarter  |      |  | 49.6 |      |  | 11.1 |  |  | 44.3 |  |  | 9.9  | 
| | Fourth
  Quarter |      |  | 49.4 |      |  | 11.5 |  |  | 40.6 |  |  | 9.4  | 

| |                 |      |  |      |      |  |      |  |  |      |  |  |     |  |  | 
| | --------------- | ---- |  | ---- | ---- |  | ---- |  |  | ---- |  |  | --- |  |  | 
| |                 | 2005 |  |      | High |  | Low  | 
| |                 |      |  |      |      |  |      | 
| |                 |      |  | NIS  |      |  | $    |  |  | NIS  |  |  | $   | 
| | First
  Quarter |      |  | 48.0 |      |  | 11.0 |  |  | 41.0 |  |  | 9.4 | 

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

| |          |      |  |      |      |  |      |  |     |      |  |   |      |  |  | 
| | -------- | ---- |  | ---- | ---- |  | ---- |  | --- | ---- |  | - | ---- |  |  | 
| |          | 2004 |  |      | High |  | Low  | 
| |          |      |  |      |      |  |      | 
| |          |      |  |      |      | 
| |          |      |  | NIS  |      |  | $    |  | NIS |      |  | $ |     
| | December |      |  | 45.0 |      |  | 10.5 |  |     | 41.8 |  |   | 9.7  | 
| |          |      |  |      |      |  |      |  |     |      |  |   |      |  |  | 
| |          | 2005 |  |      |      |  |      |  |     |      |  |   |      |  |  | 
| |          |      |  |      |      |  |      |  |     |      |  |   |      |  |  | 
| | January  |      |  | 47.9 |      |  | 10.9 |  |     | 43.5 |  |   | 9.9  | 
| | February |      |  | 48.0 |      |  | 11.0 |  |     | 45.2 |  |   | 10.4 | 
| | March    |      |  | 47.6 |      |  | 10.9 |  |     | 41.0 |  |   | 9.4  | 
| | April    |      |  | 43.3 |      |  | 9.9  |  |     | 41.8 |  |   | 9.6  | 
| | May      |      |  | 44.2 |      |  | 10.0 |  |     | 42.0 |  |   | 9.5  | 

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.

84

---

---



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.

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.

85

---

---



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 the annual budget of the Blue Square group; b) approve
any material transaction and material action involving the Blue Square group;
c) appoint the senior officers of the Blue Square group and determine their
terms of employment; d) appoint the chairman of the board of directors of Blue
Square and determine the terms of his or her service; e) approve the issuance
of securities of Blue Square or securities of other companies of the Blue
Square group; f) approve the entering into new lines of business by the Blue
Square group; or g) determine the
signatory rights in the Blue Square group.

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:

86

---

---



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

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

Blue
Squares Articles of Association provide
that, subject to the Israeli Companies Law, all actions executed 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 or by the general manager
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.

87

---

---



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 right or any other
right to purchase the companys security. Neither our Articles of Association
nor the laws of the State of Israel restrict the ownership or voting of
ordinary shares by non-residents of Israel, except for subjects of countries
which are enemies of Israel.

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

Notices. Under
the Israeli Companies Law and our Articles of Association, we are required to
publish notices in two daily newspapers at least 14 calendar days prior notice
of an ordinary shareholders meeting and at least 21 calendar days prior
notice of any shareholders meeting in which the agenda includes matters which
may be voted on through voting instruments. According to the Israeli
Companies Law and its regulations for purposes of determining the shareholders
entitled to notice and to vote at such meeting, the board of directors may fix
the record date not more than 40 nor less than four calendar days prior to the
date of the meeting, provided that an announcement regarding the general
meeting shall be given prior to the record date.

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

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

88

---

---



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

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

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

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

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

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

Private Placements

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.

89

---

---



Under
our Articles of Association, a private placement of Blue Squares shares
constituting, or securities convertible into, more than ten percent of Blue
Squares outstanding share, requires the approval of the board of directors and
Blue Squares shareholders.

American Depositary Receipts

The
following is a summary of the material provisions of the Deposit Agreement,
into which Blue Square entered
with The Bank of New York, referred to as Depositary, and all owners and
holders from time to time of ADRs issued under that agreement. This summary does not purport to be complete
and is qualified in its entirety by reference to the Deposit Agreement, a copy
of which has been filed as an exhibit to Blue Squares Registration Statement
under the Securities Law of 1933, as amended (Registration
No. 333-05024). Additional copies
of the Deposit Agreement are available for inspection at the corporate trust
office of the Depositary in New York, currently located at 101 Barclay Street,
New York, New York 10286, referred to as the Corporate Trust Office.

ADRs
evidencing ADSs were issued by the Depositary under the Deposit Agreement. Each ADS represents one ordinary share
deposited with the Custodian (as defined in the Deposit Agreement), as agent of
the Depositary. A single ADR may evidence
any number of ADSs. Only persons in
whose names ADRs are registered on the books of the Depositary are treated by
Blue Square and the Depositary as owners and holders of ADSs.

Deposit and Withdrawal of Securities

Ordinary
shares that are represented by the ADSs were deposited with the Custodian and
registered in the name of the Depositary, or its nominee or the Custodian or
its nominee. The Depositary or its
nominee or the Custodian or its nominee is the holder of record of all the
ordinary shares on behalf of the holders of ADRs. Subject to the terms and conditions of the Deposit Agreement,
upon deposit of ordinary shares with the Custodian, the Depositary issued ADSs
and executed and delivered the applicable ADS or ADRs.

Upon
surrender of ADRs at the Corporate Trust Office of the Depositary, and upon payment
of the taxes, fees and charges provided in the Deposit Agreement and subject to
their terms, ADR holders are entitled to delivery, at the office of the
Custodian in Israel, of ordinary shares, and any other property or documents of
title that the surrendered ADRs evidence the right to receive.

90

---

---



Under the
Deposit Agreement, the Depositary may execute and deliver ADRs prior to the
receipt of ordinary shares, referred to as a Pre-Release, and deliver ordinary
shares upon the receipt and cancellation of ADRs which have been Pre-Released,
whether or not that cancellation is made prior to the termination of such
Pre-Release or the Depositary knows that these ADRs have been
Pre-Released. The Depositary may
receive ADRs in lieu of ordinary shares in satisfaction of a Pre-Release. Each Pre-Release is (a) preceded or
accompanied by a written representation from the person to whom ADRs are to be
delivered that the person, or its customer, owns the ordinary shares or ADRs to
be remitted, as the case may be, (b) at all times fully collateralized
with cash or such other collateral as the Depositary deems appropriate,
(c) terminable by the Depositary on not more than five business days
notice, and (d) subject to such further indemnities and credit regulations
as the Depositary deems appropriate.
The number of ADSs which are outstanding at any time as a result of
Pre-Releases is required to not normally exceed 30% of the ordinary shares
deposited under the Deposit Agreement; provided, however, that the Depositary reserves the
right to change or disregard that limit from time to time as it deems
appropriate. The Depositary may retain
for its own account any compensation received by it in connection with the
foregoing.

Dividends, Other Distributions and Rights

Whenever
the Depositary shall receive foreign currency, the Depositary shall, subject to
any restrictions imposed by Israeli laws, regulations or applicable exchange
control permits issued by the Israeli Controller of Foreign Exchange, convert
or cause to be converted all cash dividends and other cash distributions that
it receives in respect of the underlying ordinary shares into dollars and
distribute the amount received, net of any conversion commissions or expenses
of the Depositary, to the holders of ADRs in proportion to the number of ADSs representing these shares held by
each of them. The amount distributed
also will be reduced by any amounts required to be withheld by Blue Square, the
Depositary or the Custodian for applicable taxes. If the Depositary determines that any foreign currency received
by it cannot be so converted on a reasonable basis and transferred to the
United States, the Depositary may distribute, or in its discretion hold, such
foreign currency, without liability for interest thereon, for the respective
accounts of the ADR holders entitled to receive the same.

If a
distribution by Blue Square consists of a dividend in or free distribution of
ordinary shares, the Depositary, shall, unless otherwise instructed by Blue
Square, distribute to the holders of outstanding ADRs, in proportion to their
holdings, additional ADRs evidencing an aggregate number of ADSs that represent
the number of ordinary shares received as such dividend or free distribution,
net of any expenses, fees, taxes or applicable charges. If additional ADRs are not so distributed,
each ADS shall thereafter also represent the additional ordinary shares
distributed in respect of the ordinary shares represented by that ADS prior to
the dividend or free distribution.

91

---

---



If Blue
Square offers, or causes to be offered, to holders of ordinary shares any
rights to subscribe for additional ordinary shares or any rights of any other
nature, the Depositary, after consultation with Blue Square, shall have
discretion as to the procedures to be followed in making these rights available
to any holder of ADRs or in disposing of these rights and making the net
proceeds available to that holder. If
the Depositary determines in its discretion that it is lawful and feasible to
make these rights available to all holders of ADRs or certain holders of ADRs
but not others, the Depositary may make these rights available to those holders
of ADRs to whom it determines the distribution to be lawful and feasible in
proportion to the number of ADSs held by them by means of warrants or
otherwise. If making these rights
available to all or certain holders of ADRs is determined by the Depositary in
its discretion not to be lawful or feasible, the Depositary may sell these
rights or warrants or other instruments in proportion to the number of ADSs
held by owners to whom it has determined it may not lawfully and feasibly make
these rights available, and allocate the proceeds of these sales, net of fees,
expenses, taxes and any other applicable charge, for the account of the holders
of ADRs otherwise entitled to these proceeds, upon an averaged or other
practicable basis without regard to any distinctions among these holders
because of exchange restrictions, or the date of delivery of any ADR or ADRs,
or otherwise. The net proceeds so
allocated to the holders of ADRs entitled thereto will be distributed to the
extent practicable as in the case of a distribution of cash. If, by the terms of the rights offering or
for any other reason, the Depositary may not either make these rights available
to any holders of ADRs or dispose of these rights and make the proceeds
available to these holders, then the Depositary will allow the rights to lapse.

The
Depositary will not offer rights to holders of ADRs unless both the rights and
the securities to which these rights relate are either exempt from registration
under the Securities Act with respect to a distribution to these holders or are
registered under the provisions of the Securities Act. However, nothing in the Deposit Agreement
will create, or be construed to create, any obligation on the part of Blue
Square to file a registration statement with the Securities and Exchange Commission
or endeavor to have a registration statement declared effective in order to
allow rights to be made available to owners.
If a holder of ADRs requests distribution of warrants or other
instruments, notwithstanding that there has been no such registration under
that Act, the Depositary will not make a distribution unless it has received an
opinion from recognized counsel in the United States for Blue Square, upon
which the Depositary may rely, stating that the distribution to that holder is
exempt from registration.

If the
Depositary determines that any distribution of property (other than cash),
ordinary shares or rights to subscribe to ordinary shares cannot be made
proportionately among the holders of the ADRs entitled to the distribution or
that any such distribution is not feasible for any reason, including any
requirement that the Depositary or Blue Square is obligated to withhold any
taxes or other governmental charges or that these securities must be registered
under the Securities Act in order to be distributed, the Depositary may dispose
of all or a portion of that property, ordinary shares or rights in these
amounts and in that manner, including by public or private sale, as the
Depositary deems equitable and practicable, and the Depositary shall distribute
the net proceeds of any sale, after deduction of the fees of the Depositary as
provided in the Deposit Agreement, to the ADR holders entitled to these
proceeds in a manner similar to a cash distribution.

92

---

---



Record Dates

Whenever
any cash dividend or other cash distribution becomes payable, any distribution
other than cash shall be made, or rights shall be issued with respect to the
ordinary shares, or whenever the Depositary receives notice of any meeting of
holders of the ordinary shares or shareholders generally, the Depositary shall
fix a record date. The record date
shall be the same as the record date fixed by Blue Square applicable to the
ordinary shares, or, if that record date is different, fixed after consultation
with Blue Square, if practicable. Holders
of ADRs as of the record date are entitled to receive these dividend,
distribution or rights, or net proceeds of the sale thereof, or to give
instructions for the exercise of voting rights at any meeting, subject to the
provisions of the Deposit Agreement.

Value of the Underlying Deposited Securities

Upon
receipt of notice of any meeting or solicitation of consents or proxies of
holders of ordinary shares, the Depositary has agreed to mail to holders of
ADRs registered on the books of the Depositary, a notice in English containing
(a) the information contained in the notice received by the Depositary,
(b) a statement that each holder of ADRs at the close of business on a
specified record date will be entitled, subject to the applicable provisions of
law and to Blue Squares Articles of Association, to instruct the Depositary as
to the exercise of the voting rights, if any, pertaining to the ordinary shares
represented by the ADSs evidenced by that holders ADRs, and (c) a
statement as to the manner in which instructions may be given, including, when
applicable, an express indication that instructions may be given, or, if
applicable, deemed given in accordance with the Deposit Agreement to the
Depositary to give a discretionary proxy to a person designated by Blue
Square. Upon the written request of a
holder of ADRs on the record date received on or before the date established by
the Depositary for such purpose, the Depositary has agreed to endeavor, insofar
as practicable and subject to the applicable provisions of law, the Deposit
Agreement and Blue Squares Articles of Association, to vote or cause to be
voted the ordinary shares represented by the ADSs in accordance with any
instruction set forth in such request. Blue Square has agreed, without increasing its obligations or potential
liability to the holders of ADRs, to provide notice, to the extent practicable,
of any meeting of holders of ordinary shares or shareholders generally to the
Depositary sufficiently in advance of such meeting in order to enable the
Depositary to vote or cause to be voted the ordinary shares represented by ADSs
in accordance with the Deposit Agreement.
The Depositary shall not vote or attempt to exercise the right to vote that
attaches to the ordinary shares or other deposited securities, other than in
accordance with such instructions or deemed instructions. If after complying with the procedures set
forth in this paragraph, the Depositary either (a)does not receive instructions from the
owner of an ADR, or (b) receives instructions that have been left blank on or
before the date established by the Depositary for such purposes, the Depositary
gives a discretionary proxy to vote the ordinary shares evidenced by that ADR
to a person designated by Blue Square; provided, however, that in the case of (a) above, no such
discretionary proxy shall be given with respect to any matter as to which Blue
Square informs the Depositary, and Blue Square agrees to provide such
information as promptly as practicable in writing that (1) Blue Square does not
wish such proxy given or the proxy would not be valid under applicable Israeli
law, (2) such proposition involves any solicitation of opposing proxies, or (3)
such proposition authorizes the liquidation or dissolution of Blue Square or
any merger or consolidation or other transaction involving the acquisition of a
majority of Blue Squares outstanding ordinary shares which requires the
consent of the holders of Blue Squares ordinary shares, including the
deposited securities.

93

---

---



Amendment and Termination of the Deposit
Agreement

The form of
the ADRs and the Deposit Agreement may at any time be amended by agreement
between Blue Square and the Depositary.
Any amendment that imposes or increases any fees or charges, other than
taxes and other governmental charges, registration fees, cable, telex or
facsimile transmission costs or other such expenses, or that otherwise
prejudices any substantial existing right of ADR owners, will not apply to
outstanding ADRs until the expiration of 30 days after notice of the amendment
has been given to the record holders of outstanding ADRs. Every holder of ADRs at the time the
amendment becomes effective will be deemed, by continuing to hold the ADR, to
consent and agree to the amendment and to be bound by the Deposit Agreement or
the ADR as amended. In no event may any
amendment impair the right of any ADR holder to surrender his ADR and receive
the ordinary shares and other property represented by the ADR, except to comply
with mandatory provisions of applicable law.

The
Depositary has agreed to terminate the Deposit Agreement, whenever so directed
by Blue Square, by giving notice of termination to the holders of all ADRs then
outstanding at least 30 days prior to the date fixed in the notice of
termination. The Depositary likewise
may terminate the Deposit Agreement by giving Blue Square and the holders of
ADRs notice at any time 30 days after the Depositary shall have delivered to
Blue Square a notice of its election to resign, provided that a successor
depositary shall not have been appointed and accepted its appointment before
the end of the 30-day period. If any
ADRs remain outstanding after the date of termination, the Depositary will
discontinue the registration of transfer of ADRs, will suspend the distribution
of dividends to the holders of ADRs and will not give any further notices or
perform any further acts under the Deposit Agreement, except that the
Depositary will continue (a) the collection of dividends and other
distributions pertaining to ordinary shares and any other property represented
by these ADRs, (b) the sale of rights or property, as provided in the Deposit Agreement, and (c) the delivery of
ordinary shares, together with any dividends or other distributions received
and the net proceeds of the sale of any rights or other property, after
deducting applicable fees, expenses and taxes, in exchange for surrendered
ADRs. At any time after the expiration
of one year from the date of termination, the Depositary may sell the ordinary
shares and any other property represented by the ADRs and hold the net
proceeds, together with any other cash then held, uninvested and without
liability for interest, for the pro rata benefit of the holders of ADRs that
have not surrendered their ADRs. After
effecting the sale, the Depositary shall be discharged from all obligations
under the Deposit Agreement, except to account for net proceeds and other cash,
after deducting applicable fees of the Depositary, expenses and taxes and
except for specified obligations for indemnification set forth in the Deposit
Agreement. Upon the termination of the
Deposit Agreement, Blue Square will also be discharged from all its obligations
under the agreement, except for specified obligations to the Depositary.

94

---

---



General

The
transfer of the ADRs is registerable on the books of the Depositary. However, the Depositary may close the
transfer books at any time or from time to time when it deems expedient in
connection with the performance of its duties.
As a condition precedent to
the execution and delivery, registration of transfer, split-up, combination or
surrender of any ADR or the withdrawal of any ordinary shares or any property
represented by the ADR, the Depositary, the Custodian or the registrar may
require from the holder or the presenter of the ADR or the depositor of the
shares (a) payment of a sum sufficient to pay or reimburse it for any tax or
other governmental charge and any stock transfer or registration fee or any charge
of the Depositary upon delivery of the ADR or upon surrender of the ADR, as set
forth in the Deposit Agreement, and (b) proof satisfactory to the
Depositary or Custodian of identity or genuineness of any signature and proof
of citizenship, residence, exchange control approval, legal or beneficial
ownership, compliance with all applicable laws and regulations, compliance with
all other applicable provisions of or governing the ordinary shares and the
terms of the Deposit Agreement or other information as the Depositary may deem
necessary or proper. The delivery and
transfer of ADRs and registration of transfers of outstanding ADRs generally
may be suspended during any period when the transfer books of the Depositary
are closed, or if any such action is deemed necessary or advisable by the
Depositary or Blue Square at any time or from time to time.

Notwithstanding
anything in the Deposit Agreement or the ADRs to the contrary, the surrender of
the ADRs and withdrawal of deposited securities may not be suspended except for
(a) temporary delays caused by closing transfer books of the Depositary or
Blue Square or the deposit of shares in connection with voting at a
shareholders meeting or the payment of dividends, (b) the payment of
fees, taxes and similar charges and (c) compliance with any laws or
governmental regulations relating to ADRs or to the withdrawal of deposited
securities.

C.        Material
Contracts.

For a
summary of material contracts, see Item 4.
Information on Blue SquareProperty, Plants and Equipment, Item
5. Operating and Financial Review and
Prospects  Liquidity and Capital Resources  Debentures, Item 6. Directors, Senior Management and
EmployeesC. Board PracticesExemption, Insurance and Indemnification of
Directors and OfficersLimitations on Insurance and Indemnification, Item
6. Directors, Senior Management and
Employees  D. Employees, Item 7.
Major Shareholders and Related Party Transactions B. Related Party
Transactions,, Item 10. Additional
Information B. Memorandum and Articles of Association Description of
SecuritiesAmerican Depositary Receipts and our consolidated financial
statements and notes included elsewhere in this annual report.

95

---

---



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).

The
discussion is based on legislation yet to be subject to judicial or
administrative interpretation, there can be no assurance that the views
expressed herein will accord with any such interpretation in the future.

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, certain financial companies,
broker-dealers, investors that actually or constructively own 10% or more of
our voting securities, investors that hold ordinary shares or ADSs as part of
straddle or hedging or conversion transaction, traders in securities, banks and
other financial institutions, some of which may be subject to special rules.

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.

96

---

---



Israeli
Tax Reform

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

It should
be noted that various issues related to the 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.

It
should be noted that, as stipulated and derived from the dual listing and due
to the 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.

Corporate
Tax Structure

General

The
regular rate of corporate tax in Israel is 34%, it is scheduled to be reduced
to 32% in 2006 and 30% for year 2007 and thereafter.

According
to a tax reform plan to be submitted by the Finance Ministry to the Knesset for
its consideration, the corporate tax rate would undergo further reduction up to
25% in the year 2010.

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

Corporate
Taxation Under Inflationary Conditions

The Income
Tax Law (Inflationary Adjustments), 1985, generally referred to as the
Inflationary Adjustments Law, represents an attempt to overcome the problems
presented to a traditional tax system by an economy undergoing rapid inflation.
The Inflationary Adjustments Law is highly complex. Its features which are
material to us pertain to a special tax adjustment for the preservation of
equity as follows:

97

---

---



|  |                                                                                                                                                                                                                                                                                                                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.
|  |                                                                                                                                                                                                                                                                                                                                                                                                          
| | 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.                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                          
| | Gains on traded securities are taxable when realized. However, securities dealers are subject to
  the regular tax rules applicable to business income in Israel.                                                                                                                                                                                                                                        

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.

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. The Real Gain accrued upon the sale of an asset, other than
trading securities, purchased on or after January 1, 2003 is taxed at an
applicable 25% rate, both for individuals and for corporations, as opposed to
the previous 36% rate applicable to corporations, and to the marginal tax rate
of up to 50% applicable to individuals with respect to sale transactions
effected prior to January 1, 2003.

Real Gains
derived from the disposal after January 1, 2003 of an asset, other than trading securities, purchased
prior to that date will be subject to capital gains tax at a blended rate. The regular
corporate tax rate of 34%, and a marginal tax rate of up to 49% for
individuals, will be applied to the gain amount in the same ratio to the total
gain realized as the ratio which the holding period commencing at the acquisition
date and terminating on January 1, 2003 bears to the total holding
period. The remainder of the gain
realized will be subject to capital gains tax at the beneficial 25% rate.

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

98

---

---



Upon
the sale of an asset subject to capital gains tax, a tax advance of 25% of the
capital gain is payable within 30 days of the transaction. The Assessing
Officer may accept the actual amount of tax payable, if this is lower, provided
that a detailed return which includes a computation of the tax due, is filed
within that period. 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 (34% for a corporation (32% in 2006 and 30%
for year 2007 and thereafter) and a marginal tax rate of up to 49% for individuals).

Note
that according to a tax reform plan to be submitted by the Finance Ministry to
the Knesset for its consideration, the corporate tax rate would undergo a
further reduction of up to 25% (44% for individuals) in the year 2010.

Taxation
of Israeli Residents

| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | Israeli
  Resident Shareholders subject to the Inflationary Adjustments Law.

The
Inflationary Adjustments Law includes provisions concerning taxation on gains
derived from the sale of traded securities. These provisions apply to most
corporate shareholders and to certain individuals. There is some uncertainty as
to whether these provisions also apply to foreign corporations that hold our
shares because non-resident companies are not expressly exempt from them. A
shareholder who is subject to the Inflationary Adjustments Law will be taxed,
upon the sale of his or her Shares, on the full amount of his or her gain at
the tax rate applicable to that shareholder (34% for a corporation and a
marginal tax rate of up to 49% for individuals). It should be noted that the
Tax Reform has not altered significantly the legal situation concerning this
aspect of Israeli
taxation.

| |   |                                                                                 
| | - | --------------------------------------------------------------------------------
| |  | Israeli
  Resident Shareholders not subject to the Inflationary Adjustments Law.

As
mentioned above, in November 2000 our ordinary shares were listed for trading
on the Tel Aviv Stock Exchange. As a result of our dual listing and due to the
Tax Reform (inclusion of new provisions concerning the taxation of capital
markets) and that since our ordinary shares are not considered foreign traded
securities, the tax treatment of our shareholders under Israeli law has
changed.

The
following is a summary of the most significant Israeli capital gains tax
implications arising with respect to the sale of our Shares by shareholders that are not engaged in the business of
trading securities or who are not subject to
the Inflationary Adjustments Law. As demonstrated below, shareholders purchase
date may determine the tax outcomes in this regard.

99

---

---



It
should be noted that our analysis is based partially on guidelines published by
the Israeli Tax Authorities prior to the legislation of the Tax Reform
concerning the tax treatment of securities traded in the Tel Aviv Stock Exchange
and on foreign stock exchanges abroad. Accordingly, the analysis may change
should new legislation or amended guidelines concerning this aspect be
published in the future.

| |   |                                                 
| | - | ------------------------------------------------
| |  | Sale of Shares Purchased after January 1,
  2003

The
shareholder will be subject to tax at a rate of 15% on realized real capital
gain. To the extent that the shareholder claims a deduction of financing
expenses or the sale is to a relative as defined in the Israeli Tax Ordinance,
the gain will be subject to tax at a rate of 25%.

Note
that according to a tax reform plan to be submitted by the Finance Ministry to
the Knesset for its consideration, the tax rate for selling traded securities
would increase up to 20%.

| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | Sale of Shares Purchased after the listing
  on the Tel Aviv Stock Exchange and before January 1, 2003

The
shareholder will be subject to tax on the gain derived commencing from January
1, 2003 at a rate of 15%. The cost value of the shares for the purpose of the
gain computation will be based on the average price of the shares during the
last three trading days preceding January 1, 2003 or the adjust original cost
of the shares, whichever is higher. In the last case, the capital loss that
might be offset is the difference between the adjusted average value and the
value of the shares at the date of the sale. To the extent that the taxpayer
claims a deduction of financing expenses or the sale is to a relative as
defined in the Israeli tax Ordinance, the gain will be subject to tax at a rate
of 25%.

The
remainder of the gain realized (i.e., the real gain attributed to the period
from the purchase date until January 1, 2003) will be exempt from Israeli tax.

| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | Sale of Shares Purchased prior to the listing on the Tel Aviv Stock
  Exchange

Different
tax rules may apply to shareholders who purchased their shares prior to the
listing on the Tel Aviv Stock Exchange.
Shareholders should consult with their own tax advisors for the precise
treatment upon sale.

Capital
Taxation of Non-Israeli Residents.

As
mentioned above, Israeli law generally imposes a capital gains tax on sales of
capital assets, including securities and any other direct or indirect rights to
capital assets located in Israel. This tax is also applicable to non-residents
of Israel as follows:

|  |                                                                                                                                                                                                                                                                                                                                                                               
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Foreign investors (individuals and corporations) that are not engaged
  in a business of trading securities through a permanent establishment in
  Israel and are not subject to the Inflationary Adjustments Law, who purchased
  the shares after the listing on the Tel Aviv Stock Exchange will be exempt
  from tax on capital gains derived from the sale of the Shares.

100

---

---



|  |                                                                                                                                                                                                                                                                                                                             
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Foreign corporations will not be entitled to such exemption if an
  Israeli resident (i) has a controlling interest of 25% or more in such
  non-Israeli corporation or (ii) is the beneficiary of or is entitled to
  25% or more of the revenues or profits of such foreign corporation, whether
  directly or indirectly.

Different taxation
rules may apply to shareholders who purchased their shares prior to the listing
on the Tel Aviv Stock Exchange.  Shareholders should consult with their
own tax advisors for the precise treatment upon sale.

Under
interpretations of the law and according to the Israeli tax authorities, the
above exemption will occur also on foreign investors (individuals and
corporations) that are not engaged in a business of trading securities and are
not subject to the Inflationary Adjustments Law, who purchased securities
before the listing on the Tel Aviv Stock Exchange.

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 15% from the real gain.

Dividends

The
distribution of dividend income, other than bonus shares (stock dividends), to
Israeli residents who purchased our Shares will generally be subject to income
tax at a rate of 25% for individuals and will be exempt from income tax for
resident corporations.

Non-residents
of Israel (both individuals and corporations) are subject to income tax on
income accrued or derived from sources in Israel, including dividends from
Israeli corporations. The distribution of dividend income, other than bonus
shares (stock dividends), to non-residents of Israel will generally be subject
to income tax at a rate of 25% by way of a tax withholding, unless a lower rate
is stipulated by a treaty between Israel and the shareholders country of
residence.

Taxation of Residents of the United States Under the US Treaty

Residents of the United
States will generally be subject to withholding tax in Israel on dividends
paid, if any, on Shares. Generally, under the Convention between the Government
of the United States and the Government of the State of Israel with respect to
Taxes on Income (US Treaty), the maximum rate of withholding tax on dividends
paid to a holder of Shares who is a resident of the United States (as defined
in the US Treaty) will be 25%, but
is reduced to 12.5% if the dividends are paid to a corporation that holds in
excess of 10% of the voting rights of Blue Square during Blue Squares taxable
year preceding the distribution of the dividend and the portion of Blue
Squares taxable year in which the dividend was distributed.The withheld tax is the final tax in Israel
on dividends paid to nonresidents who do not conduct a business in Israel.

101

---

---



A
non-resident of Israel that has dividend income derived from or accrued in
Israel, from which tax was withheld at the source, is generally exempt from the
duty to file tax returns in Israel in respect of such income, provided such
income was not connected to or derived from a trade or business conducted in
Israel by the tax payer.

Capital Gains

The
US Treaty exempts from taxation in Israel any capital gain realized on the
sale, exchange or other disposition of Shares by a holder that is a resident of
the United States for purposes of the US Treaty, unless the above holder owns
directly or indirectly, 10% or more of our voting stock at all times during the
12-month period preceding such sale, exchange or other disposition or unless
the above shareholder is an individual and was present in Israel for more than
183 days during the relevant taxable year. However, under the US treaty,
residents of the United States (as defined in the US Treaty) would be permitted
to claim a credit for this tax against U.S. federal income tax imposed on the
sale, exchange or other disposition, subject to the limitations in U.S. laws
applicable to foreign tax credits. The US treaty does not relate to U.S. state
or local taxes.

The
application of the US Treaty provisions to dividends and capital gains
described above is conditioned upon the fact that such income is not
effectively connected with a permanent establishment (as defined in the US
Treaty) maintained by the non-Israeli resident in Israel.

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.

102

---

---



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

This
discussion is based on current provisions of the Internal Revenue Code of 1986,
as amended, current and proposed Treasury regulations promulgated thereunder,
and administrative and judicial decisions as of the date hereof, all of which
are subject to change, possibly on a retroactive basis. This discussion does not address all aspects
of United States federal income taxation that may be relevant to any particular
shareholder based on such shareholders individual circumstances. In particular, this discussion considers
only U.S. holders that will own ordinary shares as capital assets and does not
address the potential application of the alternative minimum tax or United
States federal income tax consequences to U.S. holders that are subject to
special treatment, including U.S. holders that:

|  |                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | are
  broker-dealers or insurance companies;                                                                                                              
|  |                                                                                                                                                           
| | have elected
  mark-to-marketing accounting;                                                                                                              
|  |                                                                                                                                                           
| | are
  tax-exempt organizations;                                                                                                                           
|  |                                                                                                                                                           
| | are
  financial institutions or financial services entities;                                                                                            
|  |                                                                                                                                                           
| | hold ADSs or
  ordinary shares as part of a straddle, hedge or conversion transaction
  with other investments;                                       
|  |                                                                                                                                                           
| | own
  directly, indirectly or by attribution at least 10% of Blue Squares shares
  representing at least 10% of Blue Squares shareholders voting power;
|  |                                                                                                                                                           
| | have a
  functional currency that is not the dollar.                                                                                                      

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

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

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

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.

103

---

---



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.

104

---

---



Taxation of
the Disposition of Ordinary Shares

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

Tax Consequences
if Blue Square is a Passive Foreign Investment Company

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

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

105

---

---



|  |                                                                                                                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

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 2004.  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.

106

---

---



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:

|  |                                                                                                                                                                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

107

---

---



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.

108

---

---



|         |                                                             
|-------- | ------------------------------------------------------------
|ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES
  ABOUT MARKET RISK

Interest Rate Sensitivity

The table
below provides information about Blue Squares financial instruments that are
sensitive to changes in interest rates.

|                                                                        |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|----------------------------------------------------------------------- |  | --------------------------------------------------------- | ------- | ---- |  | ------- |  | ---- | ------- | ---- |  | -------------------------- |  | ----- | ------ |  |  | ------- |  |  | ------- | 
|                                                                        |  | December 31, 2004 
  Expected Maturity (NIS in thousands) |        
|                                                                        |  |                                                           |        
|                                                                        |  | 2005                                                      |         | 2006 |  | 2007    |  | 2008 |         | 2009 |  | from
  2010 and thereafter |  | Total |       
|                                                                       
|Long term loan from bank                                                |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|Linked to the
  Swiss Frank                                             |  |                                                           | -       |      |  | 49,482  |  |      | -       |      |  | -                          |  |       | -      |  |  | -       |  |  | 49,482  | 
|Long term loans from banks                                              |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|Linked to the
  CPI  5.2% (average fixed rate as of December 31, 2004) |  |                                                           | 60,262  |      |  | 103,963 |  |      | 64,672  |      |  | -                          |  |       | -      |  |  | -       |  |  | 228,897 | 
|                                                                        |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|Long term loans from Bank  unlinked                                    |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|                                                                       
|Average Fixed Rate (6.8%)                                               |  |                                                           | 41,557  |      |  | 16,008  |  |      | 12,501  |      |  | 6,250                      |  |       | -      |  |  | -       |  |  | 76,316  | 
|                                                                       
|Variable Rate                                                           |  |                                                           | 34,698  |      |  | 58,333  |  |      | 58,333  |      |  | 8,333                      |  |       | 8,333  |  |  | 4,167   |  |  | 172,197 | 
|                                                                        |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|                                                                        |  |                                                           |         |      |  |         |  |      |         |      |  |                            |  |       |        |  |  |         |  |  |         | 
|                                                                        |  |                                                           | 136,517 |      |  | 227,786 |  |      | 135,506 |      |  | 14,583                     |  |       | 8,333  |  |  | 4,167   |  |  | 526,892 | 
|                                                                       
|Debentures - Linked to the CPI - fixed rate
  (5.9%) (1)                |  |                                                           | -       |      |  | -       |  |      | -       |      |  | -                          |  |       | -      |  |  | 200,000 |  |  | 200,000 | 
|                                                                       
|Convertible Debentures (1)                                              |  |                                                           |         |      |  |         |  |      |         |      |  | 62,064                     |  |       | 62,064 |  |  | 62,065  |  |  | 186,193 | 

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

Inflation Risks and Exchange Rate Risks

In
accordance with Israeli Accounting Standards No. 12 and No. 17 adopted by the
Israeli Accounting Standards Board, our financial statements ceased to be
adjusted for inflation in Israel for periods beginning on or after January 1,
2004. The amounts included in our financial statements as of December 31, 2003
served as the starting point for nominal financial reporting beginning January
1, 2004. The adoption of Standard No. 12 could have material adverse effect on
our results of operations. As a result of the adoption of these standards, 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.

109

---

---



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

| |      |  |     |  |                   |    |  |  |  |     |    | 
| | ---- |  | --- |  | ----------------- | -- |  |  |  | --- | -- | 
| |      |  | CPI |  | The known index |   
| |      |  |     |  |                   |   
| |      |  |     |  |                   |    |  |  |  |     |    | 
| | 2002 |  |     |  | 6.5               | %  |  |  |  | 6.7 | %  | 
| | 2003 |  |     |  | (1.9              | )% |  |  |  | (2  | )% | 
| | 2004 |  |     |  | 1.2               | %  |  |  |  | 0.9 | %  | 

The table below provides an analysis of monetary assets and liabilities
by currency and linkage as of December 31, 2004:

|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|------------------------------------------------------- |  | ---------------- | --------- | ----------------------------------------- |  | ------- |  |  | ------ |  |  | ------ | 
|                                                        |  | Israeli Currency |           | Other Currenciesespecially
  the
  Dollar |  | Other   | 
|                                                        |  |                  |           |                                           |  |         | 
|                                                        |  | Unlinked         |           | Linked to theIsraeli CPI                  |  |         |  |  |       
|                                                        |  | NIS in thousands |          
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|Cash and cash equivalents                               |  |                  | 42,957    |                                           |  | -       |  |  | 1,650  |  |  | 2,752  | 
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|Trade receivables                                       |  |                  | 483,524   |                                           |  | -       |  |  | -      |  |  | -      | 
|Other accounts receivables                              |  |                  | 50,889    |                                           |  | 56,262  |  |  | -      |  |  | -      | 
|Investments in affiliates                               |  |                  | -         |                                           |  | 2,041   |  |  | -      |  |  |        | 
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|                                                        |  |                  | 577,370   |                                           |  | 58,303  |  |  | 1,650  |  |  | 2,752  | 
|                                                       
|Short-term credit from banks                            |  |                  | 24        |                                           |  | -       |  |  | -      |  |  | -      | 
|                                                       
|Trade payables                                          |  |                  | 834,245   |                                           |  | -       |  |  | 3,512  |  |  | -      | 
|                                                       
|Other accounts payables                                 |  |                  | 325,097   |                                           |  | 6,517   |  |  | 38,971 |  |  | -      | 
|                                                       
|Long term loans from banks including current maturities |  |                  | 248,513   |                                           |  | 228,897 |  |  | -      |  |  | 49,482 | 
|Debentures                                              |  |                  | -         |                                           |  | 200,000 |  |  | -      |  |  | -      | 
|                                                       
|Convertible debentures                                  |  |                  | -         |                                           |  | 186,193 |  |  | -      |  |  | -      | 
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|                                                        |  |                  | 1,407,879 |                                           |  | 621,607 |  |  | 42,483 |  |  | 49,482 | 
|                                                       
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 
|Monetary liabilities, net                               |  |                  | 830,509   |                                           |  | 563,304 |  |  | 40,833 |  |  | 46,730 | 
|                                                       
|                                                        |  |                  |           |                                           |  |         |  |  |        |  |  |        | 

|         |                                                         
|-------- | --------------------------------------------------------
|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY
  SECURITIES
|         |                                                         
|         | Not
  applicable.                                       

110

---

---



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) 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, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting.

|         |                                 
|-------- | --------------------------------
|ITEM 16. | [RESERVED]                      
|         |                                 
|ITEM16A. | AUDIT COMMITTEE FINANCIAL EXPERT

The Board
of Directors has determined that Zeev Vurembrand is an audit committee
financial expert as defined in Item 16A of Form 20-F.

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

111

---

---



|          |                               
|--------- | ------------------------------
|ITEM 16C. | ACCOUNTANTS FEES AND SERVICES

Kesselman
& Kesselman, a member of PriceWaterhouseCoopers International Limited,
served as our independent public accountants for the fiscal year ended December
31, 2004, and Kost Forer Gabbay & Kasierer (Kost Forer), a member of Ernst
& Young Global, served as our independent public accountants for the fiscal
year ended December 31, 2003, in each case for which audited financial
statements appear in this Annual Report on Form 20-F.

The
following table presents the aggregate fees for professional services and other
services rendered by such accountants to us during their respective term as our
principal accountants in 2003 and 2004.

| |                    |  |          |           |          |  |         | 
| | ------------------ |  | -------- | --------- | -------- |  | ------- | 
| |                    |  | 2003 (1) |           | 2004 (2) | 
| |                    |  |          |           |          | 
| |                    |  | (In NIS) |           | (In NIS) | 
| |                    |  |          |           |          |  |         | 
| | Audit Fees (3)     |  |          | 640,999   |          |  | 437,845 | 
| | Tax Fees (4)       |  |          | 367,000   |          |  | 108,239 | 
| | All Other Fees (5) |  |          | 394,567   |          |  | 61,464  | 
| |                    |  |          |           |          |  |        
| | TOTAL              |  |          | 1,402,566 |          |  | 607,548 | 

| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Fees paid to Kost Forer during their term as our
  principal accountants.                                                                                                                                                                                                                                                                                                                                                                                          
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | (2) | Fees paid to Kesselman during their term as our principal accountants.                                                                                                                                                                                                                                                                                                                                                                                             
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | (3) | Audit Fees consist of fees billed for the annual audit services
  engagement and other audit services, which are those services that only the
  external auditor can reasonably provide, and include the group audit;
  statutory audits; comfort letters and consents; attest services; and assistance
  with and review of documents filed with the SEC.                                                                                                         
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | (4) | 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, transfer pricing,
  and requests for rulings or technical advice from taxing authority; tax
  planning services; and expatriate tax planning and services.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | (5) | All Other Fees include fees billed for data security reviews,
  treasury control reviews and process improvement and advice.                                                                                                                                                                                                                                                                                                                                       

112

---

---



Audit Committee
Pre-Approval Policies and Procedures

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

|          |                                                                          
|--------- | -------------------------------------------------------------------------
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR
  AUDIT COMMITTEES.            
|          |                                                                          
|          | Not applicable.                                                          
|          |                                                                          
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE
  ISSUER AND AFFILIATED PURCHASERS.
|          |                                                                          
|          | None.                                                                    

113

---

---



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).                                                               
|            |  |                                                                                                                                                                                                                                                                                  
|2.1         |  | Form
  of Deposit Agreement (incorporated by reference to Exhibit (a) to the
  Registration Statement on Form F-6 (File No. 333-05158)).                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                  
|4.1         |  | Service
  Agreement made and entered into on the 1st day of January 1990 between
  Blue Square Chain (Super Super) Ltd. and Blue Square Chain (Hyper Hyper) Ltd.
  (incorporated by reference to Exhibit 10.10 to the Registration Statement on
  Form F-1 (File No. 333-05024)).
|            |  |                                                                                                                                                                                                                                                                                  
|4.2         |  | Supply
  Agreement made and entered into on the 1st day of January 1990 between
  Blue Square Chain (Super Super) Ltd. and Blue Square Chain (Hyper Hyper) Ltd.
  (incorporated by reference to Exhibit 10.11 to the Registration Statement on
  Form F-1 (File No. 333-05024)). 
|            |  |                                                                                                                                                                                                                                                                                  
|4.3         |  | Management
  Agreement made and entered into on July 23, 1996 between Blue Square
  Chain Investments & Properties Ltd. and the Registrant (incorporated by
  reference to Exhibit 10.12 to the Registration Statement on Form F-1 (File
  No. 333-05024)).                      
|            |  |                                                                                                                                                                                                                                                                                  
|4.4         |  | An
  Agreement to Loan Employees made and entered into on July 23, 1996
  between Blue Square Chain Properties (Hyper Hyper) Ltd. and the Registrant
  (incorporated by reference to Exhibit 10.13 to the Registration Statement on
  Form F-1 (File No. 333-05024)).            
|            |  |                                                                                                                                                                                                                                                                                  
|4.5         |  | Agreement
  made and entered into on July 25, 1996 between the Registrant and Blue
  Square Chain (Hyper Hyper) Ltd. regarding property selection (incorporated by
  reference to Exhibit 10.14 to the Registration Statement on Form F-1 (File
  No. 333-05024)).               
|            |  |                                                                                                                                                                                                                                                                                  
|4.6         |  | Registration
  Rights Agreement, dated as of July 25, 1996, by and among the Registrant
  and Co-Op Blue Square Consumers Cooperative Society Ltd. (incorporated by
  reference to Exhibit 10.15 to the Registration Statement on Form F-1 (File
  No. 333-05024)).              

114

---

---





|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|           
|4.7         |  | Letter,
  dated July 1, 1996, by Co-Op Blue Square Consumers Cooperative Society
  Ltd. indemnifying the Registrant against certain real estate tax liabilities
  (incorporated by reference to Exhibit 10.17 to the Registration Statement on
  Form F-1 (File No. 333-05024)).                                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.8         |  | Letter,
  dated May 21, 1993 and March 18, 1993, by Co-Op Blue Square
  Consumers Cooperative Society Ltd. indemnifying Blue Square Chain Investments
  & Properties Ltd. against certain real estate tax liabilities
  (incorporated by reference to Exhibit 10.18 to the Registration Statement on
  Form F-1 (File No. 333-05024)).                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.9         |  | Form
  of Letter of Exemption and Indemnity adopted in February 2001 (incorporated
  by reference to Exhibit 4.13 to Blue Squares Annual Report on Form 20-F for
  the year ended December 31, 2000).                                                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.10        |  | Form
  of Letter of Exemption and Indemnity (English translation accompanied by the
  Hebrew original). (incorporated by reference to Exhibit 4.14 to Blue Squares
  Annual Report on Form 20-F for the year ended December 31, 2001).                                                                                                                                                                                                        
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.11        |  | Special
  Collective Agreement made on the 28th day of May 1996 between Co-Op Blue
  Square Consumers Cooperative Society Ltd., the Registrant and The New
  Federation of Labor in Israel/The Federation of Clerical, Administrative and
  Services Employees and Consumers Cooperative UnionCentral Cooperative
  Society Ltd. (incorporated by reference to Exhibit 10.4 to the Registration
  Statement on Form F-1 (File No. 333-05024)).

115

---

---





|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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     |  | Loan
  Agreement made on the 5th day of June 1996 between the Registrant and
  Blue Square Chain Investments & Properties Ltd. (incorporated by
  reference to Exhibit 10.5 to the Registration Statement on Form F-1 (File No.
  333-05024)).                                                                                                                                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|4.17     |  | Deed
  of Trust made on August 5, 2003, by and between Blue Square  Israel Ltd. and
  Israel Discount Bank Trust Company Ltd., together with second schedule
  (English translation) (incorporated by reference to Exhibit 4.18 to Blue
  Squares Annual Report on Form 20-F for the year ended December 31, 2003).                                                                                                                                                           
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|4.18     |  | First
  Schedule to Deed of Trust  Debenture Certificate for Registered Debenture
  (Series A) of NIS 1 par value each (out of series of NIS 200,000,000 par
  value Debentures (Series A)) (English translation) (incorporated by reference
  to Exhibit 4.19 to Blue Squares Annual Report on Form 20-F for the year
  ended December 31, 2003).                                                                                                                            
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|4.19     |  | First Schedule to Deed of Trust  Debenture Certificate for
  Registered Debenture (Series B) of NIS 1 par value each (out of series of NIS
  200,000,000 par value Debentures (Series B)) (English translation)
  (incorporated by reference to Exhibit 4.20 to Blue Squares Annual Report on
  Form 20-F for the year ended December 31, 2003).                                                                                                                              
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|4.20     |  | Agreement
  between the Registrant and Blue Square Chain (Hyper Hyper) Ltd. (incorporated
  by reference to Exhibit 4.21 to Blue Squares Annual Report on Form 20-F for
  the year ended December 31, 2002).                                                                                                                                                                                                                                                                   
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|8        |  | List
  of Subsidiaries (incorporated  by  reference  to Exhibit 8 to Blue  Squares  Annual  Report on Form 20-F for the year
ended December 31, 2004).                                                                                                                                                                                                                                                                                                                         
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|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.                                                                                                                                                                                                                                                                                                                                      

116

---

---



---

---

# BLUE SQUARE 
ISRAEL LTD.

# CONSOLIDATED FINANCIAL
STATEMENTS

# 2004 ANNUAL REPORT

# INDEX

|                                                                                | Page          
|------------------------------------------------------------------------------- | --------------
|Reports of Independent Registered Public Accounting Firms                       | F - 2         
|Consolidated Balance Sheets                                                     | F - 3 - F - 4 
|Consolidated Statements of Operations                                           | F - 5         
|Statements of Changes in Shareholders' Equity                                   | F - 6         
|Consolidated Statements of Cash Flows                                           | F - 7 - F - 8 
|Notes to Consolidated Financial Statements                                      | F - 9 - F - 49
|Appendix to the Financial Statements - Schedule of Principal Investee Companies | F - 50        



---

---



---

| | Kesselman & Kesselman
Certified  Public   Accountants (Isr.)
Trade Tower, 25 Hamered Street
Tel Aviv 68125 Israel
P.O Box 452 Tel Aviv 61003
Telephone +972-3-7954555
Facsimile +972-3-7954556
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of

# BLUE SQUARE 
ISRAEL LTD

We have audited the accompanying
consolidated balance sheet of Blue Square  Israel Ltd. (hereafter  the
Company) and its subsidiaries as of December 31,2004 and the related consolidated
statements of operations, changes in shareholders equity and cash flows for the year
then ended. These financial statements are the responsibility of the Companys Board
of Directors and management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements for the years ended
December 2003 and 2002 were audited by other auditors, whose reports thereon, dated March
8, 2004 and March 24, 2003, respectively were unqualified.

We conducted our audit in accordance
with standards of the Public Company Accounting Oversight Board (United States of America)
and with auditing standards generally accepted in Israel including those prescribed by the
Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes 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 audit 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 as of December 31,
2004 and the consolidated results of operations, changes in shareholders equity and
cash flows for the year then ended, in conformity with accounting principles generally
accepted in Israel.

Accounting principles generally
accepted in Israel vary in certain significant respects from accounting principles
generally accepted in the United States and as allowed by item17 to Form 20-F. 
Information relating to the nature and effect of such differences is presented in note 18
to the consolidated financial statements.

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

|               |                                    
|-------------- | -----------------------------------
|
|
|
|
|Tel-Aviv       | Kesselman & Kesselman              
|March 20, 2005 | Certified Public Accountants (Isr.)

F - 2

---

---



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

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Shareholders of

# BLUE SQUARE 
ISRAEL LTD.

We
have audited the accompanying consolidated balance sheet of Blue Square  Israel Ltd.
(the Company) and subsidiaries as of December 31, 2003, and the related
consolidated statements of operations, changes in shareholders equity and cash flows
for the year then ended. These financial statements are the responsibility of the
Companys Board of Directors and management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

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

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

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



---

---



| |                   
| | ------------------
| | Luboshitz Kasierer

# REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS

# To the Shareholders
of BLUE SQUARE  ISRAEL LTD.

We have audited the accompanying
consolidated statements of operations, changes in shareholders equity and cash flows
of BLUE SQUARE  ISRAEL LTD. (the Company) and subsidiaries for the year
ended December 31, 2002. These financial statements are the responsibility of the
Companys Board of Directors and management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated results of operations, changes in shareholders equity and cash flows of
the Company and subsidiaries for the year ended December 31, 2002, in conformity with
accounting principles generally accepted in Israel, which differ in certain respects from
those generally accepted in the United States (see Note 18 to the consolidated financial
statements).

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

| |  | LUBOSHITZ KASIERERAn affiliate member of Ernst & Young International
| |  | --------------------------------------------------------------------

Tel-Aviv, Israel
March 24, 2003



---

---



|BLUE SQUARE - ISRAEL LTD.  
|---------------------------
|CONSOLIDATED BALANCE SHEETS
|                           

|                                                                     |  |  |        | Conveniencetranslation
(Note 2p)
|-------------------------------------------------------------------- |  |  | ------ | --------------------------------
|
|
|
|
|                                                                     |  |  |        |                                 
|ASSETS                                                               |  |  | 11, 13 |                                 
|                                                                     |  |  |        |                                 
|CURRENT ASSETS:                                                      |  | 
|Cash and cash equivalents                                            |  |  | 2c     |                                 
|Marketable securities                                                |  |  |        |                                 
|Trade receivables                                                    |  |  | 15a    |                                 
|Other accounts receivable                                            |  |  | 15b    |                                 
|Inventories                                                          |  |  | 15c    |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|Total current assets                                                 |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|INVESTMENT IN AN ASSOCIATED COMPANY                                  |  |  | 3      |                                 
|                                                                     |  |  |        |                                 
|FIXED ASSETS, NET OF    ACCUMULATED DEPRECIATION    AND AMORTIZATION |  |  | 4      |                                 
|                                                                     |  |  |        |                                 
|OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION:                       |  |  | 5      |                                 
|Goodwill                                                             |  |  |        |                                 
|Deferred charges                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 
|                                                                     |  |  |        |                                 

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

F - 3

---

---



|BLUE SQUARE - ISRAEL LTD.  
|---------------------------
|CONSOLIDATED BALANCE SHEETS
|                           

|                                             |  |  |        | Conveniencetranslation
(Note 2p)
|-------------------------------------------- |  |  | ------ | --------------------------------
|
|
|
|
|                                             |  |  |        |                                 
|LIABILITIES AND SHAREHOLDERS' EQUITY         |  |  | 11, 13 |                                 
|CURRENT LIABILITIES:                         |  | 
|Short-term credit from banks                 |  |  | 15d    |                                 
|Trade payables                               |  |  |        |                                 
|Other accounts payable and accrued expenses  |  |  | 15e    |                                 
|Dividend payable                             |  |  |        |                                 
|                                             |  |  |        |                                 
|Total current liabilities                    |  |  |        |                                 
|                                             |  |  |        |                                 
|LONG-TERM LIABILITIES:                       |  | 
|Long-term loans from banks, net of current   |  | 
|maturities                                   |  |  | 6      |                                 
|Debentures                                   |  |  | 7      |                                 
|Convertible debentures                       |  |  | 7      |                                 
|Deferred income taxes                        |  |  | 12b    |                                 
|Liability for employee rights, net of amount |  | 
|funded                                       |  |  | 8      |                                 
|                                             |  |  |        |                                 
|Total long-term liabilities                  |  |  |        |                                 
|                                             |  |  |        |                                 
|CONTINGENT LIABILITIES AND COMMITMENTS       |  |  | 9      |                                 
|                                             |  |  |        |                                 
|MINORITY INTEREST                            |  |  |        |                                 
|                                             |  |  |        |                                 
|SHAREHOLDERS' EQUITY:                        |  | 
|Share capital -                              |  | 
|Ordinary shares of NIS 1 par value -         |  | 
|Authorized: 100,000,000 shares at December   |  | 
|31, 2004 and 2003; Issued and outstanding:   |  | 
|38,782,336 and 38,400,000 shares at          |  | 
|December 31, 2004 and 2003, respectively     |  |  | 10     |                                 
|Additional paid-in capital                   |  |  |        |                                 
|Retained earnings:                           |  | 
|Dividend declared subsequent to balance      |  | 
|sheet date                                   |  |  |        |                                 
|Unappropriated                               |  |  |        |                                 
|                                             |  |  |        |                                 
|                                             |  |  |        |                                 
|                                             |  |  |        |                                 
|                                             |  |  |        |                                 
|                                             |  |  |        |                                 

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

|March 20, 2005                               |                                                                                         |                                                 |                                                         
|-------------------------------------------- | --------------------------------------------------------------------------------------- | ----------------------------------------------- | --------------------------------------------------------
|                                             |                                                                                         |                                                 |                                                         
|Date of approval of the
financial statements | David Wiessman        
Vice Chairman and     
Acting Chairman of the
Board of Directors | Gil Unger              
Chief Executive Officer | Emanuel Avner
Vice President and
Chief Financial Officer

F - 4

---

---



|BLUE SQUARE - ISRAEL LTD.            
|-------------------------------------
|CONSOLIDATED STATEMENTS OF OPERATIONS
|                                     

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

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

F - 5

---

---



|BLUE SQUARE - ISRAEL LTD.                    
|---------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             

|                                        |  |  | Retained earnings
|--------------------------------------- |  |  | -----------------
|
|
|
|
|Balance as of January 1, 2002           |  |  |                  
|                                        |  |  |                  
|Dividend paid                           |  |  |                  
|Net income                              |  |  |                  
|                                        |  |  |                  
|                                        |  |  |                  
|Balance as of December 31, 2002         |  |  |                  
|                                        |  |  |                  
|Dividend paid                           |  |  |                  
|Dividend declared subsequent to balance |  | 
|sheet date                              |  |  |                  
|Net loss                                |  |  |                  
|                                        |  |  |                  
|                                        |  |  |                  
|Balance as of December 31, 2003         |  |  |                  
|                                        |  |  |                  
|Issuance of shares upon conversion of   |  | 
|convertible debentures                  |  |  |                  
|Dividend paid                           |  |  |                  
|Dividend declared                       |  |  |                  
|Net income                              |  |  |                  
|                                        |  |  |                  
|                                        |  |  |                  
|Balance as of December 31, 2004         |  |  |                  
|                                        |  |  |                  

|                                      | Convenience translation into U.S. dollars in thousands (Note 2p)
|------------------------------------- | ----------------------------------------------------------------
|
|
|
|
|Balance as of January 1, 2004         |                                                                 
|                                      |                                                                 
|Issuance of shares upon conversion of |                                                                 
|convertible debentures                |                                                                 
|Dividend paid                         |                                                                 
|Dividend declared                     |                                                                 
|Net income                            |                                                                 
|                                      |                                                                 
|                                      |                                                                 
|Balance as of December 31, 2004       |                                                                 
|                                      |                                                                 

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

F - 6

---

---



|BLUE SQUARE - ISRAEL LTD.            
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     

|                                                       |  |  |  | Conveniencetranslation(Note 2p)
|------------------------------------------------------ |  |  |  | -------------------------------
|
|
|
|
|                                                       |  |  |  |                                
|Cash flows from operating activities:                  |  |  |  |                                
|                                                       |  | 
|Net income (loss)                                      |  |  |  | 7,241                          
|Adjustments to reconcile net income (loss) to net      |  | 
|cash provided by operating activities (a)              |  |  |  | 283,964                        
|                                                       |  |  |  |                                
|                                                       |  | 
|Net cash provided by operating activities              |  |  |  | 291,205                        
|                                                       |  |  |  |                                
|                                                       |  | 
|Cash flows from investing activities:                  |  | 
|                                                       |  | 
|Purchase of fixed assets                               |  |  |  | (243,234                       
|Acquisition of minority interest in subsidiary         |  |  |  | -                              
|Acquisition of partner's interest in partnership       |  |  |  | (6,854                         
|Investment grants                                      |  |  |  | 2,259                          
|Proceeds from sale of fixed assets                     |  |  |  | 13,707                         
|Collection of receivables from sale of investment      |  | 
|in previously consolidated company                     |  |  |  | 29,445                         
|Deconsolidation of previously proportionately          |  | 
|consolidated company (b)                               |  |  |  | -                              
|Proceeds from sale of (investments in) marketable      |  | 
|securities, net                                        |  |  |  | 5,563                          
|Long term loan to a former investee company, net       |  |  |  | -                              
|                                                       |  |  |  |                                
|                                                       |  | 
|Net cash used in investing activities                  |  |  |  | (199,114                       
|                                                       |  |  |  |                                
|                                                       |  | 
|Cash flows from financing activities:                  |  | 
|                                                       |  | 
|Dividends paid                                         |  |  |  | (127,678                       
|Dividend paid to minority shareholders of              |  | 
|subsidiaries                                           |  |  |  | (24,995                        
|Increase (decrease) in the balance with previous       |  | 
|parent cooperative, net                                |  |  |  | 15,390                         
|Receipt of long-term loans                             |  |  |  | 203,724                        
|Repayments of long-term loans and debentures           |  |  |  | (180,535                       
|Issuance of debentures and convertible                 |  | 
|debentures, net of issuance expenses                   |  |  |  | -                              
|Short-term credit from banks, net                      |  |  |  | 34,348                         
|                                                       |  |  |  |                                
|                                                       |  | 
|Net cash used in financing activities                  |  |  |  | (79,746                        
|                                                       |  |  |  |                                
|                                                       |  | 
|Increase (decrease) in cash and cash equivalents       |  |  |  | 12,345                         
|Cash and cash equivalents at the beginning of the year |  |  |  | 1,362                          
|                                                       |  |  |  |                                
|                                                       |  | 
|Cash and cash equivalents at the end of the year       |  |  |  | 13,707                         
|                                                       |  |  |  |                                
|                                                       |  | 
|Supplemental disclosure of cash flow activities:       |  | 
|                                                       |  | 
|Cash paid during the year for interest                 |  |  |  | 33,103                         
|                                                       |  |  |  |                                
|                                                       |  | 
|Cash paid during the year for taxes                    |  |  |  | 108,159                        
|                                                       |  |  |  |                                

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

F - 7

---

---



|BLUE SQUARE - ISRAEL LTD.            
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     

|                                                                               |  |  |  | Conveniencetranslation(Note 2p)
|------------------------------------------------------------------------------ |  |  |  | -------------------------------
|
|
|
|
|                                                                               |  |  |  |                                
|(a) Adjustments to reconcile net income (loss)                                 |  |  |  |                                
|to net cash provided by operating activities:                                  |  | 
|                                                                               |  | 
|Income and expenses not involving operating          cash flows:               |  | 
|                                                                               |  | 
|Depreciation and amortization                                                  |  |  |  | 154,138                        
|Minority interest                                                              |  |  |  | 5,953                          
|Shares in losses (profits) of an associated company                            |  |  |  | 363                            
|Profit distributions by partnership                                            |  |  |  | 2,373                          
|Loss from sale, disposal and impairment of                                     |  | 
|fixed assets and investments                                                   |  |  |  | 147,772                        
|Deferred income taxes, net                                                     |  |  |  | (33,886                        
|Erosion of (linkage differences on)                                            |  | 
|long-term loans and other liabilities, net                                     |  |  |  | (15,804                        
|Increase (decrease) in liability for                                           |  | 
|employee rights, net                                                           |  |  |  | (3,282                         
|Increase in value of marketable securities                                     |  | 
|and deposits                                                                   |  |  |  | (5,563                         
|                                                                               |  | 
|Changes in operating assets and liabilities:                                   |  | 
|                                                                               |  | 
|Decrease (increase) in trade receivables and                                   |  | 
|other accounts receivable                                                      |  |  |  | 31,900                         
|Decrease (increase) in inventories                                             |  |  |  | 8,699                          
|Increase (decrease) in trade payables and                                      |  | 
|other accounts payable                                                         |  |  |  | (8,699                         
|                                                                               |  |  |  |                                
|                                                                               |  |  |  | 283,964                        
|                                                                               |  |  |  |                                
|                                                                               |  | 
|                                                                               |  | 
|(b) Deconsolidation of previously         proportionately consolidated company |  | 
|                                                                               |  | 
|Assets and liabilities of this company at          date of deconsolidation:    |  | 
|Working capital deficiency (excluding cash         and cash equivalents)       |  |  |  | -                              
|Fixed assets and investments                                                   |  |  |  | -                              
|Long term liabilities                                                          |  |  |  | -                              
|Carrying amount of the investment in date of                                   |  | 
|the deconsolidation                                                            |  |  |  | -                              
|                                                                               |  |  |  |                                
|                                                                               |  |  |  | -                              
|                                                                               |  |  |  |                                
|                                                                               |  | 
|(c) Non-cash transactions:                                                     |  | 
|                                                                               |  | 
|Sale of fixed assets on credit                                                 |  |  |  | 2,765                          
|                                                                               |  |  |  |                                
|Cancellation of purchase of fixed assets                                       |  |  |  | 2,391                          
|                                                                               |  |  |  |                                
|Purchase of partner's interest in                                              |  | 
|partnership in consideration for deposit                                       |  |  |  | -                              
|                                                                               |  |  |  |                                
|Issuance of shares upon conversion of                                          |  | 
|convertible debentures                                                         |  |  |  | -                              
|                                                                               |  |  |  |                                
|Dividend payable                                                               |  |  |  | -                              
|                                                                               |  |  |  |                                

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

F - 8

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

| | Blue
Square-Israel Ltd. (Blue Square) is an Israeli corporation which,
independently and through its subsidiaries, operates in one business segment  the
operation of chains of supermarkets in Israel. All references to the Company include,
unless the context otherwise indicates, Blue-Square and its subsidiaries. The Company
markets and sells a wide range of consumer products including food and beverages,
apparel, pharmaceuticals, housewares and cosmetics.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | c. | 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Definitions:
| | -- | ------------

| | Subsidiary |  | a
company over which the company has control and over 50% of the ownership, 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.
| | ------------------ | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 9

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 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 the underlying assets, net of the fair
value of its underlying liabilities, at time of acquisition, net of the applicable taxes.
| | -------- | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

| | Commencing
2004, the adjustment of financial statements for the effects of inflation in Israel was
discontinued, and transitory provisions for financial reporting on a nominal basis began
being applied, as explained below; notwithstanding the above, the comparative figures
included in these financial statements are based on the adjusted for  inflation
amounts previously reported:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | The
amounts adjusted for the effects of inflation in Israel, presented in the financial
statements as of December 31, 2003 (hereafter  the transition date),
were used as the opening balances for the nominal financial reporting in the following
periods. Additions made after the transition date have been included in the financial
statements at their nominal values.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
the amounts reported in 2004 are composed as follows: amounts originating from the period
that preceded the transition date are composed of their adjusted to December 2003 shekel
amount, with the addition of amounts in nominal values that were added after the
transition date, and net of amounts that were deducted after the transition date (the
retirement of such sums is effected at their adjusted values as of transition date, their
nominal values, or a combination of the two, according to the circumstances).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

| | 2) | Comparative
figures  amounts adjusted to end of 2003 shekels
| | -- | -------------------------------------------------------------

| | Through
December 31, 2003, the Company prepared its financial statements on the basis of
historical cost adjusted for the changes in the general purchasing power of Israeli
currency (NIS), based upon changes in the consumer price index (hereafter
 the CPI, see also note 13), in accordance with pronouncements of the
Institute of Certified Public Accountants in Israel (hereafter  the Israeli
Institute). The comparative figures included in these financial statements are
based on the amounts included for the prior reporting periods, as adjusted for the
changes in the general purchasing power of Israeli currency, based on the consumer price
index for December 2003 (the CPI in effect at the transition date).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Nonmonetary
items in balance sheet were adjusted in accordance with the changes in the Israeli CPI
from the date of acquisition (transaction) to December 31, 2003 (as published on January
15, 2004). Monetary items were presented in the adjusted balance sheet at their nominal
value. Investments accounted for by the equity method were based on the adjusted
financial statements of the investee companies.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 3) | 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.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 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 companies under common control by the
proportionate           consolidation method, as prescribed by Opinion 57 of the
Israeli Institute,           see also note 3.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | Goodwill
is presented in the consolidated balance sheets under other           assets and
is amortized in equal annual installments over 10 and 20 years           (mainly 20
years), commencing in the year of acquisition.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | Intercompany
balances and transactions have been eliminated.
| | -- | ------------------------------------------------------------

| | c. | Cash
and 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | The
Companys sales derive from a large number of customers and the trade receivables,
consist mainly of credit card companies. Accordingly, the Companys trade balances
do not represent a substantial concentrations of credit risks at December 31, 2004.
Management regularly monitors the balance of trade receivables, and the financial
statements include a specific allowance computed for accounts, the collectibility of
which, in the view of management, is doubtful.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Inventories
(mainly merchandise) are stated at the lower of cost or market, cost being determined by
the first-in, first-out method.
| | --------------------------------------------------------------------------------------------------------------------------------------

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

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

| | 2) | With
effect from December 31, 2002, the Company reviews whether any events have
          occurred or changes in circumstances have taken place, which might indicate
that           there has been an impairment of its investment.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 3) | Investment
in other company of which the consolidation by the proportionate           consolidation
method has been discontinued, is presented at its carrying value           as of the date
of the discontinuance of its consolidation. Since the Company           intends to
realize this investment in the short term, the balance of this           investment is
presented under other accounts receivable (see note           15b).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Fixed
assets are stated at cost less grants received and 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Depreciation
is computed by the straight-line method over the estimated useful lives of the assets.
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 over the estimated useful life of the software (generally 4
years).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | Debenture
issuance costs  these costs are amortized over the term of the debentures, in
proportion to their outstanding balance.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | j. | Convertible
debentures
| | -- | ----------------------

| | Convertible
debentures are included on the basis of the probability of their conversion. If
conversion is not probable they are recorded as liabilities at their monetary value; if
conversion is probable they are presented as a separate caption between liabilities and
shareholders equity at the higher of their monetary or nonmonetary value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | k. | Impairment
of assets
| | -- | --------------------

| | In
February 2003, Accounting Standard No. 15 of the IASB, Impairment of Assetsbecame
effective. The Standard prescribes the accounting treatment and disclosure for impairment
of assets.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
case, there is any indication that an asset may be impaired, the Company should determine
if there has been an impairment of the asset by comparing the carrying amount of the
asset to its recoverable amount. The recoverable amount is 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
permitted by Standard No. 15, the Company elected early adoption of the Standard as of
December 31, 2002.
| | ------------------------------------------------------------------------------------------------------------

| | The
Company evaluates impairment separately for each store or other cash-generating unit. In
evaluating impairment, the Company considers corporate assets relating to the stores or
other cash-generating units as well as indirect costs that are directly attributable, or
that can be reasonably and consistently allocated, to the stores or to other units.
Goodwill is evaluated for impairment in relation to the cash generating unit to which the
goodwill can be allocated; mostly, goodwill is allocated to the operations of the Companys
principal consolidated subsidiary (Blue Square Chain Investments and Properties Ltd  BSIP).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
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, 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the years 2002-2004, the Company recorded a provisions for impairment of its property,
plant and equipment, see also note 4b.
| | ------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

| | Deferred
taxes are computed for temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts taken into account for
income tax purposes (except for temporary differences in respect of land and of fixed
assets with depreciable lives in excess of 20 years that arise from adjustments for
changes in the Israeli CPI) and for carryforward losses. As to the main factors in
respect of which deferred taxes have been included  see note 12b. The Deferred
taxes are computed at the tax rates expected to apply at the time in which those
temporary differences are expected to be recovered or settled based on tax rates enacted
or substantially enacted at balance sheet date. Deferred taxes are not provided with
respect to taxes that would be incurred if investments in investee companies were sold,
as long as it is probable that the sale of the investment is not expected in the
foreseeable future. Dividends distributed from investee companies are nontaxable.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | Expenses
in respect of club awards are principally recorded in cost of sales in the period during
which the awards are earned through purchases by 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 as purchases from these suppliers are
made.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 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 - 15

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

| | The
financial statements as of December 31, 2004 and for the year then ended have been
translated into U.S. dollars at the representative rate of exchange on December 31, 2004
(U.S. $ 1 = NIS 4.308). 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.
| | -------------------------------------------

| | r. | 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
shareholders equity  dividend declared subsequent to balance sheet date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | t. | 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.
| | ---------------------------------------------------------------------------------------------------------

F - 16

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | u. | 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company declares dividend in dollars. The Company enters 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 are carried to the amount of dividend paid.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Effect
of recently issued accounting pronouncements
| | -- | ---------------------------------------------------

| | In
July 2004, the IASB issued Israeli Accounting Standard No. 19  Taxes on Income,
which is based on International Accounting Standard No. 12, that prescribes the
accounting treatment (recognition criteria, measurement, presentation and disclosure)
required for taxes on income. This accounting standard is to be applied to financial
statements covering periods commencing on, or after, January 1, 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the most part, the provisions of this standard are the same as the accounting principles
that are customarily applied at present (see 1 above).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | The
adoption of the standard is not expected to have a material effect on the Companys
financial statements in the forthcoming periods.
| | ----------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

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

|                                                           | December 31,
|---------------------------------------------------------- | ------------
|
|
|
|
|Shares:                                                    |             
|Cost of shares                                             |             
|Share in undistributed profits (net of losses) accumulated |             
|since acquisition                                          |             
|                                                           |             
|                                                           |             
|                                                           |             
|Perpetual capital notes (1)                                |             
|Long-term loans (2)                                        |             
|                                                           |             
|                                                           |             
|                                                           |             
|                                                           |             

| | (1) | Perpetual
capital notes are linked to the Israeli CPI and bear interest at an           annual rate
of 5%.
| | --- | ----------------------------------------------------------------------------------------------------------

| | (2) | The
loans are linked to the Israeli CPI and bear interest at an annual rate of           5%.
The repayment date has not yet been determined.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------

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

|                                | NIS in
thousands
|------------------------------- | ----------------
|
|
|
|
|Balance as of January 1, 2004   |                 
|                                |                 
|Share in losses                 |                 
|                                |                 
|                                |                 
|Balance as of December 31, 2004 |                 
|                                |                 

| | b. | Proportionately
consolidated companies:
| | -- | ---------------------------------------

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

| | a) | Balance
sheet data:
| | -- | -------------------

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

F - 18

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | b) | Operating
results data:
| | -- | -----------------------

|                   | Year endedDecember 31,
|------------------ | ----------------------
|
|
|
|
|Revenues           |                       
|Costs and expenses |                       

| | * | In
May 2004, a subsidiary completed the purchase of the remaining 50% of a previously
proportionately consolidated company (hereafter  Teco) share capital. Management
decided that in the event it does not succeed to realize the investment in Teco by way of
sale, it will act to discontinue Tecos operation in the near future. Consequently
the Company discontinued Tecos proportional consolidation as from the second
quarter of 2004. The investment in Teco is presented under Other accounts receivable.
There is a doubt regarding Tecos ability to continue as a going concern (see also
notes 9c and 15b).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 19

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

|                             | Land and
buildings
including
leasehold
land (1) | Leasehold
improvements | Furniture,
equipment
and
installations | Motor
vehicles | Total
|---------------------------- | ----------------------------------------------- | ---------------------- | -------------------------------------- | -------------- | -----
|
|
|
|
|Cost:                        |                                                 |                        |                                        |                |      
|                             |                                                 |                        |                                        |                |      
|Balance at January 1, 2004   |                                                 |                        |                                        | 1,801,252      |      
|Additions                    |                                                 |                        |                                        | 13,331         |      
|Disposals                    |                                                 |                        |                                        | (4,127         | )    
|Other changes (2)            |                                                 |                        |                                        | (5,631         | )    
|                             |                                                 |                        |                                        |                |      
|Balance at December 31, 2004 |                                                 |                        |                                        | 1,804,825      |      
|                             |                                                 |                        |                                        |                |      
|Accumulated depreciation and |                                                 |                       
|amortization:                |                                                 |                       
|                             |                                                 |                        |                                        |                |      
|Balance at January 1, 2004   |                                                 |                        |                                        | 244,744        |      
|Additions                    |                                                 |                        |                                        | 23,753         |      
|Eliminated on disposals      |                                                 |                        |                                        | -              |      
|Other changes (2)            |                                                 |                        |                                        | (1,018         | )    
|                             |                                                 |                        |                                        |                |      
|Balance at December 31, 2004 |                                                 |                        |                                        | 267,479        |      
|                             |                                                 |                        |                                        |                |      
|Impairment of fixed assets   |                                                 |                       
|(see b below)                |                                                 |                        |                                        | (91,509        | )    
|                             |                                                 |                        |                                        |                |      
|Net book value at            |                                                 |                       
|December 31, 2004            |                                                 |                        |                                        | 1,445,837      |      
|                             |                                                 |                        |                                        |                |      
|Net book value at            |                                                 |                       
|December 31, 2003            |                                                 |                        |                                        | 1,469,401      |      
|                             |                                                 |                        |                                        |                |      

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

| | (2) | Changes
as a result of deconsolidation of a previously proportionately
               consolidated company.
| | --- | -----------------------------------------------------------------------------------------------------------

| | b. | In
2002, due to the continuing slowdown and decline in the activities of the
               Companys business environment and due to the initial application of
               Accounting Standard No. 15 (see note 2k), the Company recorded a loss from
               impairment of assets in the amount of approximately NIS 141 million.
During                2003, due to, among others, the closure of stores (see note 15h)
and the                continuing economic slowdown, the Company recorded a net loss from
impairment of                assets of approximately NIS 41.6 million. This impairment
loss is net of a                reduction of the impairment provision, recorded during
2002, in the approximate                amount of NIS 21 million. The change in the
impairment provision in 2003                reflects updated operating and forecasted
results of the Companys                management regarding various assets.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
impairment loss is included in other expenses in the statements of operations.
| | ----------------------------------------------------------------------------------

F - 20

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | In
calculating the impairment in 2004, based on discounted expected future cash flows, the
Company used a discount rate of 8% (before tax), which was determined, among others, by
an independent expert (2003  8%, 2002  10%).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of the provision for impairment as of December 31, 2004 and 2003, is after a
reduction for depreciation in correspondence with 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, 2004:
| | -- | ----------------------------------------------------------------------------

|                                                                        | NIS
|----------------------------------------------------------------------- | ---
|
|
|
|
|Ownership                                                               |    
|                                                                        |    
|Capitalized  leaseholding from Israel Land  Administration  for periods |    
|ending  2020-2080 (including  the option  period which is relevant for  |    
|some of the lands)                                                      |    
|                                                                        |    
|                                                                        |    
|                                                                        |    

| | 2) | Part
of the ownership rights and leasehold rights has not been technically           recorded
by the name of the companies.
| | -- | ---------------------------------------------------------------------------------------------------------------------------

| | d. | As
to liens placed on assets, see note 11.
| | -- | ------------------------------------------

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

|                              | December 31,
|----------------------------- | ------------
|
|
|
|
|Goodwill                      |             
|                              |             
|                              |             
|Debenture issuance expenses   |             
|Prepaid rental expenses and   |             
|acquisition tax               |             
|Deferred taxes (see Note 12b) |             
|                              |             
|                              |             
|                              |             

F - 21

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

|                              | Annualinterestrate | December 31,
|----------------------------- | ------------------ | ------------
|
|
|
|
|In foreign currency-          |                    |             
|Swiss Frank                   |                    |             
|In Israeli currency:          |                    |             
|Linked to the Israeli CPI (3) |                    |             
|Not linked (2)                |                    |             
|                              |                    |             
|                              |                    |             
|                              |                    |             
|Less - current maturities     |                    |             
|                              |                    |             
|                              |                    |             
|                              |                    |             

| | (1) | Average
rate as of December 31, 2004.
| | --- | -------------------------------------

| | (2) | As
of December 31, 2004 includes approximately NIS 172 million at variable
          interest (average annual rate as of December 31, 2004  5%). The balance
of           approximately NIS 76 million is at a fixed annual interest rate of 6.8%.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | As
to the interest rate swap agreements that the Company entered into regarding
          these loans, see note 14c.
| | --- | --------------------------------------------------------------------------------------------------------------------

| | b. | The
long-term loans are repayable in the years subsequent to the balance sheet           date
as follows:
| | -- | ---------------------------------------------------------------------------------------------------------

|                                | December 31
|------------------------------- | -----------
|
|
|
|
|First year - current maturities |            
|Second year                     |            
|Third year                      |            
|Fourth year                     |            
|Fifth year                      |            
|Sixth year and thereafter       |            
|                                |            
|                                |            
|                                |            

| | c. | As
to collateral with respect to long-term loans - see note 11.
| | -- | ---------------------------------------------------------------

F - 22

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

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

| | These
debentures are linked (principal and interest) to the Israeli CPI, but in the event the
Israeli CPI is less than the base index (index known at date of issuance), the amount of
the debentures will not be adjusted below the base index. The principal is repayable in
three equal annual installments on August 5 of each of the years 2012 to 2014, and bears
interest at the rate of 5.9% per annum. The interest is payable semiannually on February
5 and on August 5.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Notwithstanding
the above, on August 5 of each of the years 2006, 2008 and 2010, the holders of the
debentures will be entitled to early redemption of the principal provided that on each of
the said dates the Company does not repay more than one third of the par value of the
debentures outstanding as of that date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | 200
million registered convertible debentures (Series B) of NIS 1 par value each
| | --- | --------------------------------------------------------------------------------

| | These
debentures are linked (principal and interest) to the Israeli CPI, but in the event the
Israeli CPI is less than the base index (index known at date of issuance), the amount of
the debentures will not be adjusted below the base index. The principal is repayable in
three equal annual installments on August 5 of each of the years 2007, 2009 and 2011, and
bears interest at the rate of 5.9% per annum. The interest is payable semiannually on
February 5 and on August 5.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
debentures (Series B) are convertible to ordinary shares of the Company at a conversion
ratio that is subject to adjustments in the event of distribution of bonus shares and
cash dividends and the issuance of rights. As of December 31, 2004 the conversion ratio
is that each NIS 35.2 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. Subsequent to balance sheet date, on January 24 2005, the Company distributed a
dividend in the amount of U.S. $ 9,046 thousands, which was declared in December 26, 2004
(see Note 10c). Accordingly, on that date the conversion ratio was reduced so that each
NIS 34.2 par value of debentures is convertible to one Ordinary shares of 1 NIS par value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
terms of the debentures provide that the holders of the debentures will not be entitled
to request the Company to register for trading on the New York Stock Exchange any shares
derived from the conversion of the debentures (Series B). Such shares will be traded only
on the Tel Aviv Stock Exchange (TASE).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2004, Company debentures with a par value of approximately NIS 13,807 thousand were
converted into 382,336 ordinary shares.
| | ----------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | b. | Other
terms:
| | -- | ------------

| | (1) | The
terms of the debentures (Series A and Series B) provide that in the event
               that the shares of the Company are delisted from trading on the TASE,
and/or in                the event that the shares of the Company are no longer held by
the public and/or                in the event that Maalot The Israeli Securities Rating
Company Ltd.                (Maalot) reduces the Companys rating to BBB
or lower, then                within three months from one of the abovementioned events
the Company, subject                to the then prevailing law, will offer to acquire the
debentures at a price                equivalent to the price of debentures of the same
type reflecting a return of                2.5% in excess of the return on Government
debentures with an average life                similar to the remaining average life of
the debentures of that series as of the                date of the offer, but in no event
will the price exceed the carrying value of                the debentures of that series.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | In
connection with the rating for the said debentures by Maalot, in July 2003           the
Board of Directors of the Company resolved that the Company will not           distribute
dividends in quarters in which the Company does not meet the           following
financial covenants:
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | For
the period from date of issuance of the debentures until June 30, 2006, the
          ratio between the Companys monetary liabilities (as defined by Maalot)
and           the cumulative EBITDA in the preceding four quarters will be less than 3.5,
and           for the period from the aforementioned date, the ratio will be less than 3.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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, 2004, the Company meets the aforementioned financial covenants.
| | ----------------------------------------------------------------------------------

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

F - 24

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 8 |  | LIABILITY FOR EMPLOYEE RIGHTS NET OF AMOUNT FUNDED(continued):
|------ | - | --------------------------------------------------------------

| | b. | Compensation
for unutilized sick leave
| | -- | --------------------------------------

| | Pursuant
to agreements signed between the Company and its employees, the employees are entitled
each year to 30 days of sick leave, the rights to which accumulate under certain
conditions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
accrual for unutilized sick leave included in the financial statements is based on an
independent actuarial calculation (which takes into account estimated employee turnover,
future wage levels, etc.)
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | The
balance sheet liability for employee rights upon retirement, and the amount
          funded with severance pay funds, are composed as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|                                              | December 31,
|--------------------------------------------- | ------------
|
|
|
|
|Accrued severance pay                         |             
|Less - amounts funded                         |             
|                                              |             
|                                              |             
|Provision in respect of unutilized sick leave |             
|                                              |             
|                                              |             
|                                              |             

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

|NOTE 9 |  | CONTINGENT
LIABILITIES 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

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

| | The
Director has permitted the exchange of information, so long as this is done on a
transparent and equal basis. At a later stage, the Director stated his position that
these directives constitute a position paper, which is intended to provide the direction
concerning the normative status of various practices. The Director emphasized that this
document does not have normative status.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has been applying most of these directives for some time already, inter alias by
means of an internal enforcement program that was adopted by the Company. This
notwithstanding, the Company is reviewing the Directors directives and shall act in
accordance with a legal opinions that is to be obtained. The Director of the Antitrust
Authority Findings do not refer specifically to the Company.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2002, the Director announced that the arrangements relating to the gift
          certificates issued by the Company and other supermarket chains apparently
          constitute a restrictive arrangement pursuant to the Antitrust Law.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 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 3c).           Management of the Company and its legal advisors,
are presently unable to           estimate the effect of the notification of the
Authority and its ultimate           outcome.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | On
April 9, 2003, a suit for NIS 320 million was filed against the Company and
          three other supermarket chains at the Tel Aviv District Court, together with an
          application for the suit to be recognized as a class action. The suit
stipulated           that the portion of the suit attributable to the Company amounts to
          approximately NIS 108 million.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
plaintiff is claiming compensation from the Company and the other supermarket chains for
overcharges that result from the weighing of products in bulk, together with the
packaging materials.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the plaintiff, the customer is charged an aggregate amount that includes a charge for
the packaging materials, which charge, the plaintiff alleges, is illegal.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
August 2004, a settlement was reached, according to which, the defendants have committed
to take certain measures (deducting the packaging weight in case its over 10 gr or
posting appropriate explanatory signs) as stipulated in the settlement agreement. In
addition the Company paid the petitioner a compensation of approximately NIS 184,000.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
June 2003, a petition to approve a class action suit in the aggregate amount
               of NIS 25 million was filed against the Company and certain investees in
the Tel                Aviv District Court. The petitioner is claiming damages allegedly
incurred in                respect of the unlawful rounding of amounts due from customers
for products sold                by weight in the stores of the companies.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 13, 2004 the Tel Aviv district court dismissed the request to recognize this claim
as a class action suit. Following the dismissal of the claim by the district court, the
plaintiff has appealed to the Supreme Court. After consulting its legal advisors,
management believes that there is little likelihood that the appeal will be accepted, and
accordingly, no provision with respect to this matter has been made in the financial
statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 6. | 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.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7. | 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | 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.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 9. | In
February 2004, the Company received tax assessments for the years 1999-2001,
          according to which the Company is required to pay approximately NIS 8 million.
          These assessments relate to the non-deductibility of certain expenses that were
          claimed by the Company. Management of the Company disagrees with the standpoint
          of the tax authorities and submitted an objection to these assessments. In
          managements opinion, the Company will not be required to pay material
          amounts, if any, in connection with these assessments, in excess of the
accruals           included in the financial statements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | b. | Commitments:
| | -- | ------------

| | 1. | Stores
that are operating by the Company are leased under non-cancelable           long-term
operating leases, mostly with renewal options. Rent expense under           these leases
amounted to NIS 85 million, NIS 95 million, and NIS 100           million for the
years ended December 31, 2002, 2003 and 2004, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Future
minimum payments under non-cancelable operating leases for the years subsequent to
December 31, 2004, are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------

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

| | 2. | On
October 1, 2001, the Law for Deposits on Beverage Containers, 1999 (the           law),
became effective. The Company and other supermarket chains           have entered into an
agreement with producers and importers of beverages to           establish a recycling
entity whose purpose is to set up and operate a mechanism           to implement the
provisions of the Law regarding refunds of deposits, collection           of beverage
containers and their recycling. The Company has provided a guarantee           for the
benefit of the recycling entity in the amount of NIS 333,000.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2003, the Company disassociated from the Company for Drink Containers Collection
Corporation Ltd. after giving notification of its decision to disassociate from the
corporation.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | As
of December 31, 2004, the Company has entered into agreements for the
               purchase of real estate and equipment, in the aggregate amount of
approximately                NIS 12 million.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Guarantees:
| | -- | -----------

| | 1. | A
subsidiary has provided a bank guarantee for a third party in the amount of           NIS
0.7 million.
| | -- | --------------------------------------------------------------------------------------------------------

| | 2. | As
of balance sheet date, a subsidiary granted to an associated company           guarantees
in respect of liabilities of the associated company to banks in the           amount of
NIS 1.1 million.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | The
Company has provided bank guarantees to suppliers and customers in an
               aggregate amount of approximately NIS 3.8 million.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

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

| | 4. | A
subsidiary has provided a standing guarantee letter in an unrestricted           amount,
to guarantee Tecos entire obligations and liabilities to the bank.           As of
December 31, 2004, Tecos liabilities to the bank is approximately           NIS 11
million, see also note 3b.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 10 |  | SHARE
CAPITAL:
|------- | - | --------------

| | a. | Composed
as follows:
| | -- | --------------------

|                   | Authorized | Issued and paid
|------------------ | ---------- | ---------------
|
|
|
|
|Ordinary shares of |            |                
|NIS 1 par value    |            |                
|                   |            |                

| | b. | 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) and on the International Stock
Exchange in London (SEAQ). The issued shares represent as of December 31, 2004 and 2003
21.6% and 21.9% of the outstanding Ordinary Shares of the Company, respectively. As of
December 31, 2004 the shares are quoted at $9.76 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, 2004 the shares are quoted at NIS 42.85 per
ordinary share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Dividends
| | -- | ---------

| | In
January 2004,  the Company  declared and paid a dividend in the amount of U.S.$ 45
million  (U.S.$                      1.18 per Ordinary share or ADS)
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 2004,  the Company  declared and paid a dividend in the amount of U.S.$ 11.6
 million  (U.S.$                      0.3 per Ordinary share or ADS)
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to balance sheet date, in January 2005, the Company distributed a dividend in the amount
of approximately U.S. $ 9 million (U.S. $ 0.23 per Ordinary share or ADS) which dividend
was declared in December 26, 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to restriction on dividend distribution, see note7b(2).
| | ----------------------------------------------------------

F - 30

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 11 |  | LIENS:
|------- | - | ------

| | a. | As
collateral for liabilities to banks, a proportionately consolidated company
               has registered fixed and floating charges on their land, goodwill, rights
to                insurance and share capital. As of December 31, 2004, companys
share in                the balance of liabilities collateralized amounts to NIS 1.1
million.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | To
secure liabilities of a subsidiary previously proportionately consolidated
               company in respect of benefits received in the framework of investments in
its                Approved Enterprise, the above-mentioned company fixed charges on the
machinery,                equipment and insurance rights in favor of the State of Israel
(total investment                grants received amount to approximately NIS 2.3
million). In addition the                aforementioned subsidiary registered fixed and
floating charges on all of their                current assets, fixed assets, goodwill,
rights to insurance, receivables from                credit companies and share capital
to secure its liabilities to banks. As of                December 31, 2004 these
liabilities amount to NIS 11.2 million.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Regarding
financial covenants in respect of debentures  see Note 7b(2).
| | -- | ------------------------------------------------------------------------

|NOTE 12 |  | TAXES
ON INCOME:
|------- | - | ----------------

| | a. | Corporate
taxation in Israel
| | -- | ----------------------------

| | 1. | Measurement
of results for tax purposes under the Income Tax (Inflationary
               Adjustments) Law, 1985 (hereafter the inflationary
adjustments                law)
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the inflationary adjustments law, results for tax purposes are measured in real terms,
having regard to the changes in the CPI. The Company and most of its subsidiaries are
taxed under this law.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Tax
rates
| | -- | ---------

| | The
income of the Company and its subsidiaries is taxed at the regular rate. Through to
December 31, 2003, the corporate tax was 36%. In July 2004, an amendment 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 the following manner: the rate
for 2004 will be 35%, in 2005  34%, in 2006  32%, and in 2007 and thereafter
 30%. The effect of the change in the tax rates in the coming years on the deferred
tax balances is included under the item taxes on income in the consolidated
statements of operations  see note d below.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | b. | Deferred
taxes
| | -- | --------------

| | 1) | The
composition of the deferred taxes, and the changes therein during the year,           are
as follows:
| | -- | ---------------------------------------------------------------------------------------------------------

|                             | In respect of balance sheet items |  | 
|---------------------------- | --------------------------------- |  | 
|
|
|
|
|Balance at January 1, 2003   |                                   |  | 
|Changes in 2003 -            |                                   | 
|Amounts carried to income    |                                   |  | 
|                             |                                   |  | 
|Balance at December 31, 2003 |                                   |  | 
|                             |                                   | 
|Changes in 2004 -            |                                   | 
|Amounts carried to income    |                                   |  | 
|                             |                                   |  | 
|Balance at December 31, 2004 |                                   |  | 
|                             |                                   |  | 

| | 2) | Deferred
taxes are presented in the balance sheets as follows:
| | -- | --------------------------------------------------------------

|                          | December 31
|------------------------- | -----------
|
|
|
|
|Other accounts receivable |            
|Other assets              |            
|Long-term liabilities     |            
|                          |            
|                          |            
|                          |            

| | *
Realization of this deferred tax balance is conditional upon earning, in the coming
years, taxable income in appropriate amounts.
| | -----------------------------------------------------------------------------------------------------------------------------------

| | The
deferred taxes are computed at the tax rates of 30%-34%.
| | ------------------------------------------------------------

| | c. | As
of December 31, 2004 the Company and its subsidiaries have operating tax           loss
carryforwards of approximately NIS 54 million. In addition, the Company and           its
subsidiaries have capital loss tax carryforwards of approximately NIS 22
          million. The tax benefit in respect of operating tax loss carryforwards
          amounting to NIS 0.6 million and in respect of all of the capital tax loss
          carryforwards has not been recorded due to uncertainty of their realization.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | d. | Taxes
on income included in the statements of operation:
| | -- | --------------------------------------------------------

|                                          | Year ended December 31,
|----------------------------------------- | -----------------------
|
|
|
|
|In respect of the reported year:          |                        
|Current                                   |                        
|Deferred:                                 |                        
|In respect of changes to tax rates,       |                        
|See 12 a (2) above                        |                        
|In respect of the reporting period        |                        
|Tax expense (benefit) in respect of prior |                        
|Years:                                    |                        
|Current                                   |                        
|Deferred                                  |                        
|                                          |                        
|                                          |                        
|                                          |                        
|                                          |                        

| | Current
taxes are computed in 2002 and 2003 at a tax rate of 36%; in 2004  35% (see 12 a
(2) above).
| | -----------------------------------------------------------------------------------------------------

| | e. | Effective
tax:
| | -- | --------------

| | 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:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                 | Year ended December 31,
|------------------------------------------------ | -----------------------
|
|
|
|
|Income before taxes on income, as reported in    |                        
|the statements of operations                     |                        
|                                                 |                        
|Theoretical tax expense                          |                        
|Increase (decrease) in taxes resulting from:     |                        
|Nondeductible amortization and impairment losses |                        
|in respect of goodwill and fixed assets          |                        
|Losses for which no tax benefit has been         |                        
|recorded (utilization of tax benefits not        |                        
|previously recorded), net                        |                        
|Tax expense (benefit) in respect of prior years  |                        
|Increase (decrease) in taxes resulting from      |                        
|adjustment to deferred tax balances due to       |                        
|changes in tax rates, see 12 a (2) above         |                        
|Nondeductible expenses and other, net            |                        
|                                                 |                        
|                                                 |                        
|Income tax expense                               |                        
|                                                 |                        

| | *
Including decrease in taxes in the amount of NIS 2,973 thousands regarding difference
between the measurement of income reported for tax purposes (which is calculated in real
terms on the basis of changes in the CPI) and the basis of measurement of income for
financial reporting purposes (in nominal values, commencing from January 1, 2004).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 12 |  | TAXES
ON INCOME(continued):
|------- | - | ---------------------------

| | f. | Tax
assessments:
| | -- | ----------------

| | Blue
Square has received final tax assessments, or assessments deemed to be final, for tax
years through 1998. Regarding tax assessments for the years 1999  2001, see note
9a(9). Some of the principal subsidiaries have received final assessments for tax years
through 2001. For some of the subsidiaries, no final tax assessments have been received
since their inception.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 13 |  | LINKAGE
OF MONETARY BALANCES:
|------- | - | -----------------------------

| | a. | As
follows:
| | -- | -----------

|                                                  | December 31, 2004
|------------------------------------------------- | -----------------
|
|
|
|
|Current assets:                                   |                  
|Cash and cash equivalents                         |                  
|Trade receivables                                 |                  
|Other accounts receivable                         |                  
|Investments and long-term receivables             |                  
|                                                  |                  
|                                                  |                  
|                                                  |                  
|                                                  |                  
|Current liabilities:                              |                  
|Short-term credit from banks                      |                  
|Trade payables                                    |                  
|                                                  |                  
|Other accounts payable and accrued                |                  
|Expenses                                          |                  
|Long-term liabilities:                            |                  
|Long-term  loans  from banks  (including  current |                  
|maturities)                                       |                  
|Debentures                                        |                  
|Convertible debentures                            |                  
|                                                  |                  
|                                                  |                  
|                                                  |                  

F - 34

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 13 |  | LINKAGE
OF MONETARY BALANCES(continued):
|------- | - | ----------------------------------------

| | b. | Data
regarding the exchange rate and the CPI:
| | -- | ---------------------------------------------

|                                     | Exchange rate
of one
U.S. dollar | Exchange rate
of one
euro | CPI*
|------------------------------------ | -------------------------------- | ------------------------- | ----
|
|
|
|
|At end of year:                      |                                  |                           |     
|2004                                 |                                  |                           |     
|2003                                 |                                  |                           |     
|Increase (decrease) during the year: |                                  |                          
|2004                                 |                                  |                           |     
|2003                                 |                                  |                           |     
|2002                                 |                                  |                           |     

| | * | Based
on the index for the month ending on each balance sheet date, on the basis of 2000
average = 100.
| | - | -------------------------------------------------------------------------------------------------------

|NOTE 14 |  | FINANCIAL
INSTRUMENTS AND RISK MANAGEMENT:
|------- | - | ------------------------------------------

| | a. | Concentration
of credit risks
| | -- | -----------------------------

| | Financial
instruments that potentially subject the Company to concentrations of credit risk consist
principally of trade receivables.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | The
groups sales derive from a large number of customers and the trade receivables
consist mainly of credit card companies. Management regularly monitors the balance of
trade receivables, and the financial statements include a specific allowance computed for
accounts, the collectibility of which, in the view of management is doubtful.
Accordingly, the groups trade balances do not represent a substantial
concentrations of credit risk at December 31, 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
carrying value of cash and cash equivalents, receivables, other current assets, long-term
liabilities, payables and accrued expenses equals or approximates their fair value. The
fair value of loans from banks and debentures also approximates their fair value because
they bear interest at rates that approximate market rates.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Derivative
financial instruments
| | -- | --------------------------------

| | As
of December 31, 2004, the Company had outstanding hedging derivatives, as follows:
| | -------------------------------------------------------------------------------------

| | 1. | Forward
exchange contracts for the acquisition of approximately $ 9 million
               until January 24, 2005, at the rate of NIS 4.3484.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Linkage
to the Israel CPIs swap contract in respect of long term loans                (see
note 6a), the balance of the principal of which is NIS 390 million for
               periods of up to 1 year, under which it receives a fixed rate range of
Israeli                CPI of 1.15%-1.35%.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION:
|------- | - | -----------------------------------------------

| | Balance
sheets:
| | ---------------

| | a. | Trade
receivables:
| | -- | ------------------

|                                       | December 31,
|-------------------------------------- | ------------
|
|
|
|
|Credit card receivables                |             
|Open accounts and checks receivables   |             
|                                       |             
|                                       |             
|                                       |             
|Less - allowance for doubtful accounts |             
|                                       |             
|                                       |             
|                                       |             
|                                       |             

| | b. | Other
accounts receivable:
| | -- | --------------------------

|                                                      |  |  |  |         |  |  |         | 
|----------------------------------------------------- |  |  |  | ------- |  |  | ------- | 
|Deferred income taxes (see note 12b)                  |  |  |  | 7,951   |  |  | 22,631  | 
|Prepaid expenses                                      |  |  |  | 18,033  |  |  | 15,510  | 
|Government agencies                                   |  |  |  | 46,833  |  |  | 55,812  | 
|Receivables from sale of fixed assets                 |  |  |  | 21,861  |  |  | 12,553  | 
|Investment in previously proportionately consolidated |  | 
|company                                               |  |  |  | -       |  |  | 386     | 
|Other                                                 |  |  |  | 24,084  |  |  | 38,400  | 
|                                                      |  |  |  |        
|                                                      |  | 
|                                                      |  |  |  | 118,762 |  |  | 145,292 | 
|                                                      |  |  |  |        

| | c. | Inventories:
| | -- | ------------

|                                  |  |  |  |         |  |  |         | 
|--------------------------------- |  |  |  | ------- |  |  | ------- | 
|Merchandise                       |  |  |  | 268,897 |  |  | 285,673 | 
|Parts, raw materials and supplies |  |  |  | 7,216   |  |  | 2,369   | 
|                                  |  |  |  |        
|                                  |  | 
|                                  |  |  |  | 276,113 |  |  | 288,042 | 
|                                  |  |  |  |        

| | d. | Short-term
credit from banks:
| | -- | -----------------------------

|                                      |  |  |  |         |  |  |         | 
|------------------------------------- |  |  |  | ------- |  |  | ------- | 
|1. composed as follows:               |  | 
|                                      |  | 
|Short-term credit from banks:         |  | 
|Not linked                            |  |  |  | 6,653   |  |  | 24      | 
|In Japanese Yen                       |  |  |  | 32,720  |  |  | -       | 
|Current maturities of long-term Loans |  |  |  | 173,148 |  |  | 136,517 | 
|                                      |  |  |  |        
|                                      |  |  |  | 212,521 |  |  | 136,541 | 
|                                      |  |  |  |        

| | 2. | As
to collaterals with respect to short-term credit from banks, see note 11.
| | -- | ----------------------------------------------------------------------------

F - 36

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | e. | Other
accounts payable and accrued expenses:
| | -- | --------------------------------------------

|                                 | December 31,
|-------------------------------- | ------------
|
|
|
|
|Payroll and related expenses and |             
|other employee benefits          |             
|Previous parent cooperative *    |             
|Government authorities           |             
|Customer advances                |             
|Accrued expenses and other       |             
|                                 |             
|                                 |             
|                                 |             

| | * | The
balance unlinked and bears variable interest. The average annual interest rate in 2003
was 6.0%.
| | - | ----------------------------------------------------------------------------------------------------

| | Statements
of operations:
| | -------------------------

| | f. | Selling,
general and administrative expenses:
| | -- | ---------------------------------------------

|                     | Year ended December 31,
|-------------------- | -----------------------
|
|
|
|
|Includes advertising |                        
|                     |                        

| | g. | Financial
income (expenses), net: *)
| | -- | ------------------------------------

|                                                 |  |  |  |         |   |  |         |   |  |         |  
|------------------------------------------------ |  |  |  | ------- | - |  | ------- | - |  | ------- | -
|In respect of:                                   |  | 
|Long-term loans and debentures                   |  |  |  | (14,965 | ) |  | (47,217 | ) |  | (59,494 | )
|Short-term credit, net                           |  |  |  | (1,405  | ) |  | (3,710  | ) |  | (2,839  | )
|Increase in value of marketable securities and   |  | 
|short-term deposits, net                         |  |  |  | 12,766  |   |  | 14,082  |   |  | 4,760   |  
|Purchasing power gain (loss) in respect of other |  | 
|monetary items and others, net                   |  |  |  | 19,504  |   |  | (11,968 | ) |  | (517    | )
|                                                 |  |  |  |         |   | 
|                                                 |  | 
|                                                 |  |  |  | 15,900  |   |  | (48,813 | ) |  | (58,090 | )
|                                                 |  |  |  |         |   | 
|*) Net of borrowing costs capitalized to cost of |  | 
|fixed assets                                     |  |  |  | 3,925   |   |  | 1,956   |   |  | -       |  
|                                                 |  |  |  |         |   | 

F - 37

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | h. | Other
expenses, net:
| | -- | --------------------

|                                              | Year ended December 31,
|--------------------------------------------- | -----------------------
|
|
|
|
|Compensation and employee benefits (3)        |                        
|Termination benefits in respect of efficiency |                        
|plan (2)                                      |                        
|Gain (loss) from sale of fixed assets, net    |                        
|Impairment of assets (1)(2)                   |                        
|Costs in respect of closure of stores (lease  |                        
|termination costs and other)                  |                        
|Employee rights in respect of prior years (4) |                        
|Compensation of termination of private label  |                        
|franchise                                     |                        
|Other, net                                    |                        
|                                              |                        
|                                              |                        
|                                              |                        

| | (1) | Mainly
impairment losses in respect of fixed assets, see Note 4b.
| | --- | -----------------------------------------------------------------

| | (2) | As
a result of adoption of an efficiency plan by the Company that includes
          termination of employees and closure of a number of unprofitable stores, the
          Companys consolidated statement of operations for the year ended December
          31, 2003 includes expenses in an amount of approximately NIS 26 million in
          respect of termination benefits and approximately NIS 23.5 million in respect
of           impairment of fixed assets relating to closure of unprofitable stores
          (impairment loss included in the above caption  impairment of fixed
          assets). In 2004 the Company has recorded additional amount of
          approximately NIS 4.7 million in respect of the abovementioned efficiency plan.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Following
the change in the control of the Company, agreements were reached           between the
Company and its employees and management pursuant to which the           employees are
entitled to receive certain bonuses and additional future           benefits, which
include a bonus equivalent to 1% of the amount of every dividend           to be
distributed by the Company to its shareholders, up to a maximum cumulative
          dividend distribution of U.S.$250 million. It was also agreed that in the event
          the Company makes another public offering of its shares, the Company will offer
          to the employees to purchase up to 10% of the shares offered to the public at a
          price not exceeding 80% of the minimum offering price. In the event that
          convertible securities will be offered, the employees will be entitled to a
          discount of 20% from the exercise price or the rate of conversion. In the event
          shares are offered to the public together with other securities, employees will
          be entitled to a discount of 20% only on the offering price of the shares.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of the abovementioned agreements, the Company recorded an expense of
approximately NIS 63.9 million (before income taxes and minority interest) in respect of
the aforementioned compensation and benefits to which the employees are entitled.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 15 |  | SUPPLEMENTARY
FINANCIAL STATEMENTS INFORMATION(continued):
|------- | - | ----------------------------------------------------------

| | (4) | The
Company and the previous parent cooperative had different interpretations           in
respect of the payment of certain benefits amounting to NIS 11 million for
          employees previously employed by the parent cooperative and transferred to the
          Company. As previously agreed by the parties in respect of such matters, this
          issue had been submitted to arbitration. In March 2003, the arbitrator decided
          that the above-mentioned amount is payable in its entirety by the Company.
          Accordingly, the expense was included in the statement of operations for 2002
in           other expenses (see Note 15h).
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES:
|------- | - | ----------------------------------

| | a. | Previous
parent cooperative:
| | -- | ----------------------------

|                   | Year ended December 31,
|------------------ | -----------------------
|
|
|
|
|Financial expenses |                        
|                   |                        
|Rent expense       |                        
|                   |                        
|Management fees *) |                        
|                   |                        

| | *) | Management fees
related to the period until June 2003 were charged according to agreement with the
previous parent cooperative.
| | -- | -------------------------------------------------------------------------------------------------------------------------------

| | Transactions
with a previous parent cooperative involving investment and fixed assets were recorded at
the carrying amount of such assets; the results of differences were credited to
additional paid in capital.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | In
2002, the Company assumed the liability of a former related party in
               connection with a previously joint club award program of the Company and
the                former related party. In consideration for the assumption of the
liability, the                Company received NIS 5 million from the former related
party.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Bronfman
 Alon Ltd. (the parent company) and other related parties:
| | -- | --------------------------------------------------------------------

|                              | Year ended December 31,
|----------------------------- | -----------------------
|
|
|
|
|Purchase of merchandise       |                        
|Management fees               |                        
|Directors' fees (1)           |                        
|Legal consulting              |                        
|Consulting (2)                |                        
|Purchase of fuel products (3) |                        
|Commissions (4)               |                        

| | 1) | Represents
payments to Bronfman  Alon in respect of directors fees           for two
directors of the Company and its subsidiary, in accordance with an           agreement
providing that each of the directors are entitled to monthly           remuneration in
the amount of NIS 42 thousand.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 16 |  | TRANSACTIONS
WITH RELATED PARTIES(continue):
|------- | - | --------------------------------------------

| | 2) | Represent
payments to S. Zohar in respect of consulting agreement signed on           June 2003.
Since March 2004, S. Zohar became a director of the Company and so           the amount
recorded above represents the fee payment as explained.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | The
Company and its subsidiary signed agreements to purchase from related           parties
fuel products and merchandise at market prices. Also, the companies           entered
into agreements according to which related parties will operate fast           food
services in their stores in consideration for a percentage of revenues
          described in the agreements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | In
January 2004 the shareholders of the Company approved an agreement according           to
which the Company will provide to a related party purchasing and supply
          services for stores operated by the related party. In consideration for these
          services, the Company is entitled to payment equivalent to the cost of the
          services provided with the addition of a margin as stated in the agreement.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Most
of the agreements between the Company and its subsidiaries are based on a
               long term arrangements. The Companys examination of these agreements
has                revealed that some of them have to be renewed or extended. The Company
intends                to secure required approvals from the audit committee or Board of
Directors and                if required general shareholders meeting, as soon as
possible.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 17 |  | SUBSEQUENT
EVENTS:
|------- | - | ------------------

| | a. | On
February 15 2005, the Company signed an agreement for the purchase of 50% of
               the holdings of Hamachsan Hamerkazi Kfar Hashaashuim LTD, in
consideration                for 3.2 million NIS for the shares and 21.8 million NIS as a
shareholder loan.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
agreement is subject to satisfaction of different closing conditions, including the
Israel Antitrust Authority approval.
| | ----------------------------------------------------------------------------------------------------------------------------

| | b. | In
January 2005, the Company distributed a dividend in the amount of
               approximately U.S. $ 9 million (U.S $ 0.23 share or ADS) which was
declared in                December 26, 2004.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | On
March 20, 2005, the Board of Directors of BSIP declared a
               dividend in cash in the amount of NIS 80 million. The minoritys
interest                in the abovementioned dividend amount to approximately NIS 15
million.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|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 (U.S. GAAP), and as allowed by item 17 to
Form 20-F, as described                below:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Effect
of inflation
| | -- | -------------------

| | In
accordance with Israeli GAAP, until December 31, 2003, when the adjustment of financial
statements for the effects of inflation in Israel was discontinued, the group
comprehensively included the effect of the changes in the general purchasing power of
Israeli currency in its financial statements, as described in note 2a above. In view of
the inflation in Israel, this was considered a more meaningful presentation than
financial reporting based on historical cost.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
explained in note 2a above, the amounts adjusted for the effects of inflation in Israel,
presented in the financial statements as of December 31, 2003 (hereafter  the
transition date), were used as the opening balances for the nominal financial
reporting in the following periods. As a result, amounts reported in 2004 for
non-monetary items that originated before the transition date are based on their adjusted
December 2003 shekel balance.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
allowed by the SEC, the adjustments to reflect the changes in the general purchasing
power of Israeli currency, have not been reversed in the reconciliation of Israeli GAAP
to U.S. GAAP.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Proportionate
consolidation
| | -- | ---------------------------

| | Under
Israeli GAAP, jointly controlled entities are included in the Companys consolidated
financial statements according to the proportionate consolidation method.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, investments in jointly controlled entities are accounted for by the equity
method. Pursuant to the Securities and Exchange Commission requirements applicable to
foreign private issuers, the Company is not required to disclose the differences in
classification that result from using proportionate consolidation. For the Companys
share in assets, liabilities, revenues and expenses of jointly controlled companies
consolidated by the proportionate consolidation method, see Note 3b.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Deferred
income taxes
| | -- | ---------------------

| | Under
Israeli GAAP, deferred income taxes are not provided for differences between the
financial reporting 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, deferred taxes are provided on all such differences between the financial
reporting and income tax basis of land and fixed assets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 4. | Liability
for employee rights, net of amount funded
| | -- | ---------------------------------------------------

| | According
to U.S. GAAP, accrued severance pay and related funded amounts are presented in the
balance sheet separately as a liability and asset, respectively. Income from earnings on
amounts funded is added to severance pay funds.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to Israeli GAAP, accrued severance pay is included in the balance sheet net of any
related funded amounts including the income from earnings on amounts funded.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | See
Note 8c for the presentation in the Companys balance sheet.
| | ----------------------------------------------------------------

| | 5. | Earnings
(loss) per share
| | -- | -------------------------

| | According
to Israeli GAAP, the dilutive effect of convertible securities is included in the
computation of basic earnings (loss) per share if their exercise or conversion is
considered to be probable, even if their effect is antidilutive. Calculation of the
probability is based on the ratio between the market price of the shares and the present
value of the payments for conversion of the debentures into shares. According to US GAAP,
basic earnings (loss) per share exclude all dilutive securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
above difference did not have an effect on the computation of earnings (loss) per share
for 2003 and 2004.
| | --------------------------------------------------------------------------------------------------------------

| | In
addition, under US GAAP, shares resulting from conversion of convertible securities
during a reporting period are included in the computation of basic earnings (loss) per
share on a weighted average basis  based on the period from the date of conversion,
whereas under Israeli GAAP such shares are included in the computation of basic earnings
(loss) per share from the beginning of the reporting period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Another
difference is the U.S. requirement for separate presentation in the statements of
operations of basic and diluted EPS, while, in Israel, such separate presentation is only
required if the difference between basic and diluted EPS is in excess of 5%.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | Derivative
instruments
| | -- | ----------------------

| | Under
Israeli GAAP, as noted in note 2u, 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 no
qualify for hedge accounting.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, under Israeli GAAP, gains and losses on derivatives that are hedging declared
dividend are deducted or added to the dividend amount whereas under U.S GAAP changes in
the fair value of those derivatives are carried to the statements of operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 42

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 7. | Goodwill
| | -- | --------

| | Under
Israeli GAAP, goodwill is amortized in equal annual installments over a period of 10 and
20 years (see note 2b(3), Goodwill is reviewed for impairment when circumstances indicate
the possibility that impairment exists.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP (SFAS141 and SFAS 142), goodwill that arose from acquisitions prior to July 1,
2001, was amortized until December 31, 2001 on a straight-line basis over the estimated
period of benefit and thereafter is no longer amortized. Goodwill acquired in a business
combination for which the date of acquisition is on or after July 1, 2001 is not
amortized.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP, goodwill is to be tested for impairment on adoption of SFAS 142 and at
least annually thereafter or between annual tests in certain circumstances, and written
down when impaired. Goodwill attributable to a reporting unit is tested for impairment by
comparing the fair value of the reporting unit with its carrying value. Fair value is
determined by the Company based on market value of the reporting unit. The reporting unit
to which most of the goodwill was attributed is a subsidiary, whose shares are traded on
the Tel-Aviv stock exchange, and therefore its fair value is determined by the Company
based on its shares market value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | Impairment
of long-lived assets
| | -- | -------------------------------

| | The
Company elected early adoption as of December 31, 2002, of Israeli Accounting Standard
No. 15 regarding impairment of assets (see Note 2k). According to this Standard, if the
carrying amount of an asset 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. Recoverable amount is defined as the higher of an assets
selling price and its value in use. Value in use is the present value of estimated future
cash flows expected to arise from the continuing use of an asset and from its disposal
and retirement at the end of its useful life.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP (SFAS 144  Accounting for the Impairment or Disposal of
Long-Lived Assets) an impairment loss is recognized only if the carrying amount of
an asset is not recoverable. The carrying amount is not recoverable if it exceeds the
estimated undiscounted future cash flows expected to result from the use of the asset. If
the carrying amount is not recoverable, an impairment loss should be recorded for the
amount by which the carrying value of the asset exceeds its fair value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result, certain circumstances which would require an impairment loss to be recorded
under Israeli GAAP would not require an impairment loss to be recorded under U.S. GAAP.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, in accordance with Israeli GAAP, where indicators are present that beneficial
events have occurred or beneficial changes in circumstances have taken place, the
impairment provision in respect of the asset (other than goodwill) may be cancelled or
reduced in the future, while under U.S.GAAP, this impairment loss cannot be restored and
the asset is continued to be carried in its new cost.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 9. | Compensation
expense in respect of options issued to employees
| | -- | --------------------------------------------------------------

| | Under
Israeli GAAP, the 1996 Stock Option Plan and previous options plans (which do not exist
any more) do not require the recognition of compensation expense.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the purpose of the reconciliation to U.S. GAAP, the Company has adopted the provisions of
APB Opinion No. 25 Accounting for Stock Issued to Employees. Under APB 25,
the excess, if any, of the quoted market price of the shares at the grant date over the
exercise price of the stock options, is amortized to compensation expense over the
vesting period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
respect of the reconciliation to U.S. GAAP for the reported periods, the effect of the
aforementioned difference is a reduction in retained earnings with an offsetting increase
in additional paid-in capital and with no effect on the Companys results of
operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10. | Dividend
declared subsequent to balance sheet date
| | --- | --------------------------------------------------

| | In
accordance with Israeli GAAP, dividends declared subsequent to balance sheet date are
presented as a separate component in shareholders equity. Under U.S. GAAP, such
dividends are not recorded as a separate component in shareholders equity.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 11. | Start-up
costs
| | --- | --------------

| | According
to Israeli GAAP, start up costs of a discontinued affiliate sold to the previous parent
cooperative, were capitalized and amortized over a period of between 3 and 5 years.
According to U.S. GAAP, such start up costs are charged to expense as incurred.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 12. | Classification
of certain expenses
| | --- | ----------------------------------

| | Under
Israeli GAAP, certain expenses amounting to approximately NIS 20 million, NIS 139 million
and NIS 174 million for the years ended December 31, 2004, 2003 and 2002 respectively,
are included in non-operating expenses, whereas in accordance with U.S. GAAP such items
are included in operating expenses.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 13. | Cash
flow classification
| | --- | ------------------------

| | According
to Israeli GAAP, proceeds from sale or purchase of marketable securities are presented in
cash flows from investing activities in the statement of cash flows.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP, proceeds from sale or purchase of marketable securities which are
classified by the Company as held for trading are included in cash flows from operating
activities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 14. | Convertible
debentures:
| | --- | -----------------------

| | (1) | Under
Israeli GAAP convertible debentures are included on the basis of the
          probability of their conversion. If conversion is not probable they are
recorded           as liabilities at their monetary value; if conversion is probable they
are           presented as a separate caption between liabilities and shareholders          equity
at the higher of their monetary or non-monetary value.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
U.S. GAAP, convertible debentures are recorded as liabilities at their monetary value.
| | --------------------------------------------------------------------------------------------

| | The
abovementioned difference did not have any effect on the financial statements for all
periods presented.
| | ------------------------------------------------------------------------------------------------------------

| | (2) | 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 (intrinsic value).
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 2004 and 2003, the conversion
price was adjusted to NIS 35.2 and NIS 41.8, as of December 31, 2004 and 2003,
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 2004 and 2003 a
beneficial conversion feature (credited to additional paid-in capital (APIC))
amounting to NIS 37,721 thousand (NIS 24,658 thousand after taking into consideration
deferred taxes) and NIS 2,870 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 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, 2004 and 2003, additional interest expense in the amount of NIS 9,014
thousand (NIS 5,859 thousand after taxes) and NIS 140 thousand, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to balance sheet date, the conversion price was further adjusted to NIS 34.2, due to of
another dividend distribution. As a result, the Company will record in 2005 an additional
discount on the debentures, in an amount of approximately NIS 6,598 thousand (NIS 4,355
thousand after taxes) against a credit to APIC.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
Israeli GAAP, the beneficial conversion feature component is not recognized in the
financial statements.
| | --------------------------------------------------------------------------------------------------------------

| | 15. | Reporting
comprehensive income
| | --- | ------------------------------

| | U.S.
GAAP require reporting and display of comprehensive income and its components
          in a full set of general purpose financial statements. Israeli GAAP does not
          contain such a requirement.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | With
respect to the Company, comprehensive income does not include any items other than net
income.
| | ---------------------------------------------------------------------------------------------------

F - 46

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 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:
| | -- | --------------------------------------

|                                          | Year ended December 31,
|----------------------------------------- | -----------------------
|
|
|
|
|Net income (loss) as reported, according  |                        
|to Israeli GAAP                           |                        
|Amortization of goodwill                  |                        
|Accretion of discount resulting from      |                        
|beneficial conversion feature in          |                        
|respect of convertible debentures         |                        
|Gains on derivatives                      |                        
|Impairment of long-lived assets, net of   |                        
|taxes                                     |                        
|Deferred taxes on income                  |                        
|Minority interest in respect of the above |                        
|                                          |                        
|Net income (loss) according to U.S. GAAP  |                        
|                                          |                        
|Net income (loss) per share as reported,  |                        
|according to Israeli GAAP (primary and    |                        
|fully diluted):                           |                        
|                                          |                        
|Net income (loss) per share               |                        
|                                          |                        
|                                          |                        
|Per U.S. GAAP:                            |                        
|                                          |                        
|Basic and diluted earnings (loss) per     |                        
|share                                     |                        
|                                          |                        
|                                          |                        
|Weighted average number of shares used    |                        
|for computation of earning (loss) per     |                        
|share (basic and diluted)                 |                        
|                                          |                        

F - 47

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.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 under Israeli GAAP, which is           not permitted
under U.S. GAAP.
| | -- | ---------------------------------------------------------------------------------------------------------------------

| | 3. | Difference
due to impairment losses included 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, 2003 | December 31, 2004
|------------------------------ | ----------------- | -----------------
|
|
|
|
|Severance pay fund (6)         |                   |                  
|Fixed assets, net (5)          |                   |                  
|Intangible assets and          |                   |                  
|deferred charges (4)           |                   |                  
|Deferred income taxes, net (1) |                   |                  
|Other accounts payable and     |                   |                  
|accrued expenses (8)           |                   |                  
|Accrued severance pay (6)      |                   |                  
|Convertible debentures (7)     |                   |                  
|Minority interest (3)          |                   |                  
|Additional paid-in capital (2) |                   |                  
|Retained earnings :            |                   |                  
|Dividend declared after        |                   |                  
|balance sheet date             |                   |                  
|Unappropriated (3)             |                   |                  
|Total shareholders' equity     |                   |                  

| | (1) | Effect
of difference described in a(3) above and tax effect of difference           described in
a(8) and a(14) above.
| | --- | ----------------------------------------------------------------------------------------------------------------------

| | (2) | Options
issued to employees (see a(9) above), difference in capital gain, net           of tax,
from transactions with the previous parent cooperative (see a(11)           above), and
difference in respect of convertible debentures (see a(14)(2)           above).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Net
effect of reconciling items.
| | --- | --------------------------------

| | (4) | As
for amortization of goodwill, see a(7) above.
| | --- | ------------------------------------------------

| | (5) | As
for the effect of Standard No. 15, see a(8) above.
| | --- | -----------------------------------------------------

| | (6) | See
a(4) above.
| | --- | ---------------

| | (7) | See
a(14)(2) above.
| | --- | -------------------

| | (8) | See
a(6) above.
| | --- | ---------------

F - 48

---

---



|BLUE SQUARE - ISRAEL LTD.                 
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          

|NOTE 18 |  | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN ISRAEL AND IN THEU.S.A(continued):
|------- | - | ---------------------------------------------------------------------------------------------------------------------

| | 3. | Consolidated
statements of cash flows:
| | -- | --------------------------------------

|                                      | Year ended December 31,
|------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities: |                        
|                                      |                        
|As per Israeli GAAP                   |                        
|Adjustment (1)                        |                        
|                                      |                        
|                                      |                        
|As per U.S. GAAP                      |                        
|                                      |                        
|                                      |                        
|Cash flows from investing activities: |                        
|                                      |                        
|As per Israeli GAAP                   |                        
|Adjustment (1)                        |                        
|                                      |                        
|                                      |                        
|As per U.S. GAAP                      |                        
|                                      |                        
|                                      |                        
|(1) See a(13) above                   |                        

F - 49

---

---



|BLUE SQUARE - ISRAEL LTD.           
|------------------------------------
|APPENDIX TO THE FINANCIAL STATEMENTS
|                                    

# SCHEDULE OF PRINCIPAL
INVESTEE COMPENIES 
AT DECEMBER 31, 2004

|Holding Company                | Name of Company | Percentage of
ownership and
control by holding
company as of
December 31,
2004 |                                          
|------------------------------ | --------------- | ------------------------------------------------------------------------------ | -----------------------------------------
|
|
|
|
|Blue Square-Israel Ltd.        |                 |                                                                                | The Blue Square Chain                    
|                               |                 |                                                                                | Investments & Properties Ltd.            
|                               |                 |                                                                               
|                               |                 |                                                                                | Kenyon Hadar Management                  
|                               |                 |                                                                                | Company Ltd.                             
|                               |                 |                                                                               
|                               |                 |                                                                                |                                          
|                               |                 |                                                                                | Joint venture Blue Square - Hadar        
|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.                      

| | * | As
to  investment  in Teco Ltd.  which was  previously  proportionately  consolidated,  see
note 3b in the                  financial statements
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

F - 50

---

---

SIGNATURE

The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F/A and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.

| |  | BLUE SQUARE-ISRAEL LTD.BY: /s/ Gil Unger
Gil UngerPresident and Chief Executive Officer
| |  | -----------------------------------------------------------------------------------------------------

| |  | BY: /s/ Emanuel Avner
Emanuel AvnerVice President and Chief Financial OfficerDate: January 18, 2006
| |  | -----------------------------------------------------------------------------------------------------------------



---

---