SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 20-F

|_|   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, 2002

                                       or

|_|   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 0-21388

                           Magal Security Systems Ltd.
                           ---------------------------
             (Exact name of Registrant as specified in its charter)

                                     Israel
                                     ------
                 (Jurisdiction of incorporation or organization)

                P.O. Box 70, Industrial Zone, Yahud 56100, Israel
                -------------------------------------------------
                    (Address of principal executive offices)

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

Title of each class                    Name of each exchange on which registered
-------------------                    -----------------------------------------
        None                                              None

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

                  Ordinary Shares, NIS 1.0 par value per share
                  --------------------------------------------
                                (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:

             7,696,517 Ordinary Shares, NIS 1.0 par value 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.

    |X| Yes |_| No Indicate by check mark which financial statement item the
                       registrant has elected to follow.

                             |_| Item 17 |X| Item 18

<PAGE>

                                  INTRODUCTION

      Magal Security Systems Ltd. develops, manufactures, markets and sells
complex computerized security systems, including a line of perimeter security
systems, a video motion detection system and a security management system and
provides video monitoring services. Our predecessor commenced operations in 1969
as a department specializing in perimeter security systems within the
electronics division of Israel Aircraft Industries Ltd., or IAI. Effective April
1984, we purchased from IAI substantially all of the assets, and assumed
substantially all of the related liabilities, of that department. In March 1993,
we completed an initial public offering of 1,380,000 ordinary shares and in
February 1997, we completed a public offering of an additional 2,085,000
ordinary shares. Our ordinary shares are traded on the Nasdaq National Market
and on the Tel Aviv Stock Exchange under the symbol MAGS.

      Except for the historical information contained in this annual report, the
statements contained in this annual report are forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 with respect
to our business, financial condition and results of operations. 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.D. "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" 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 U.S., we do not intend to
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.

      Our consolidated financial statements appearing in this annual report are
prepared in U.S. dollars and in accordance with U.S. generally accepted
accounting principles, or U.S. GAAP. 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. The representative exchange rate between the
NIS and the dollar as published by the Bank of Israel on June 17, 2003 was NIS
4.353 per $1.00.

      As used in this annual report, the terms "we," "us" and "our" mean Magal
Security Systems Ltd. and its subsidiaries, unless otherwise indicated.

      Statements made in this annual report concerning the contents of any
contract, agreement or other document are summaries of such contracts,
agreements or documents and are not complete descriptions of all of their terms.
If we filed any of these documents as an exhibit to this annual report or to any
registration statement or annual report that we previously filed, you may read
the document itself for a complete description of its terms.

<PAGE>

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                       Page
                                                                                                       ----
<S>                                                                                                     <C>
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
               A. Selected Consolidated Financial Data ..............................................    1

               B. Capitalization and Indebtedness ...................................................    2

               C. Reasons for the Offer and Use of Proceeds .........................................    2

               D. Risk Factors ......................................................................    2

     ITEM 4.      Information on the Company ........................................................   11
               A. History and Development of the Company ............................................   11

               B. Business Overview .................................................................   12

               C. Organizational Structure ..........................................................   26

               D. Property, Plants and Equipment ....................................................   26

     ITEM 5.      Operating and Financial Review and Prospects ......................................   27
               A. Results of Operations .............................................................   31

               B. Liquidity and Capital Resources ...................................................   37

               C. Research and Development, Patents and Licenses ....................................   41

               D. Trend Information .................................................................   41

     ITEM 6.      Directors, Senior Management and Employees ........................................   41
               A. Directors and Senior Management ...................................................   41

               B. Compensation ......................................................................   44

               C. Board Practices ...................................................................   45

               D. Employees .........................................................................   52

               E. Share Ownership ...................................................................   52

     ITEM 7.      Major Shareholders and Related Party Transactions .................................   54
               A. Major Shareholders ................................................................   54

               B. Related Party Transactions ........................................................   55

               C. Interests of Experts and Counsel ..................................................   57

     ITEM 8.      Financial Information .............................................................   57
               A. Consolidated Statements and Other Financial Information ...........................   57

               B. Significant Changes ...............................................................   58

     ITEM 9.      The Offer and Listing .............................................................   59
               A. Offer and Listing Details .........................................................   59

               B. Plan of Distribution ..............................................................   60
</TABLE>


                                       i
<PAGE>

                                TABLE OF CONTENTS
                                   (continued)

<TABLE>
<CAPTION>
                                                                                                       Page
                                                                                                       ----
<S>                                                                                                     <C>
               C. Markets ...........................................................................   60

               D. Selling Shareholders ..............................................................   60

               E. Dilution ..........................................................................   60

               F. Expenses of the Issue .............................................................   60

     ITEM 10.     Additional Information ............................................................   60
               A. Share Capital .....................................................................   60

               B. Memorandum and Articles of Association ............................................   60

               C. Material Contracts ................................................................   65

               D. Exchange Controls .................................................................   65

               E. Taxation ..........................................................................   65

               F. Dividends and Paying Agents .......................................................   77

               G. Statements by Experts .............................................................   77

               H. Documents on Display ..............................................................   77

               I. Subsidiary Information ............................................................   78

     ITEM 11.     Quantitative and Qualitative Disclosures about Market Risk ........................   78
     ITEM 12.     Description of Securities Other Than Equity Securities ............................   79

PART II .............................................................................................   79
     ITEM 13.     Defaults, Dividend Arrearages and Delinquencies ...................................   79
     ITEM 14.     Material Modifications to the Rights of Security Holders and Use of Proceeds ......   79
     ITEM 15.     Controls and Procedures ...........................................................   79
     ITEM 16.     [Reserved] ........................................................................   80

PART III ............................................................................................   80
     ITEM 17.     Financial Statements ..............................................................   80
     ITEM 18.     Financial Statements ..............................................................   80
     ITEM 19.     Exhibits ..........................................................................   80

SIGNATURE ...........................................................................................   82
</TABLE>


                                       ii
<PAGE>

                                     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 Consolidated Financial Data.

      We have derived the following selected consolidated financial data as of
December 31, 2001 and 2002 and for each of the years ended December 31, 2000,
2001 and 2002 from our consolidated financial statements set forth elsewhere in
this annual report that have been prepared in accordance with U.S. GAAP. We have
derived the following selected consolidated financial data as of December 31,
1998, 1999 and 2000 and for each of the years ended December 31, 1998 and 1999
from our audited consolidated financial statements not included in this annual
report. You should read the following selected consolidated financial data
together with the section of this annual report entitled "Operating and
Financial Review and Prospects" and our consolidated financial statements and
notes thereto included elsewhere in this annual report.

<TABLE>
<CAPTION>
                                                               Year Ended December 31,
                                               -----------------------------------------------------
                                                 1998        1999        2000        2001      2002
                                               --------    --------    --------    -------   -------
                                                        (in thousands except per share data)
<S>                                            <C>         <C>         <C>         <C>       <C>
Consolidated Statement of Income Data:
Revenues ...................................   $ 32,105    $ 31,967    $ 38,571    $41,020   $42,966
Cost of revenues ...........................     16,638      16,693      20,523     21,505    23,924
                                               --------    --------    --------    -------   -------
Gross profit ...............................     15,467      15,274      18,048     19,515    19,042
                                               --------    --------    --------    -------   -------
Operating expenses:
   Research and development, net ...........      2,259       2,676       2,975      3,054     3,128
   Sales and marketing .....................      5,781       5,820       7,129      7,933     8,642
   General and administrative ..............      4,610       4,104       4,661      4,949     4,938
                                               --------    --------    --------    -------   -------
Total operating expenses ...................     12,650      12,600      14,765     15,936    16,708
                                               --------    --------    --------    -------   -------
Operating income (loss) ....................      2,817       2,674       3,283      3,579     2,334
Financial income (expenses), net ...........       (217)       (127)       (214)        40       199
                                               --------    --------    --------    -------   -------
Income before taxes on income
   and write-off of investment in
   affiliate, net of taxes .................      2,600       2,547       3,069      3,619     2,533
Taxes on income ............................        337         259         180        452       645
                                               --------    --------    --------    -------   -------
Income before write-off of
   investment in affiliate .................      2,263       2,288       2,889      3,167     1,888
Write-off of investment in affiliate,
   net of taxes ............................         --         357          --         --        --
                                               --------    --------    --------    -------   -------
Net income .................................      2,263       1,931       2,889      3,167     1,888
                                               ========    ========    ========    =======   =======
Basic net earnings per share ...............   $   0.31    $   0.26    $   0.39    $  0.42   $  0.25
                                               ========    ========    ========    =======   =======
Number of shares used in computing
   basic net earnings per share ............      7,332       7,401       7,440      7,512     7,637
Diluted net earnings per share .............   $   0.31    $   0.26    $   0.38    $  0.41   $  0.24
                                               ========    ========    ========    =======   =======
Number of shares used in computing
   diluted net earnings per share ..........      7,341       7,473       7,525      7,694     7,834
Cash dividend per share ....................   $   0.10    $   0.10    $   0.13    $    --   $    --
                                               ========    ========    ========    =======   =======
</TABLE>

      In August 2002, we distributed a 3% stock dividend. All share and per
share data in the above table have been adjusted to reflect the stock dividend.

<PAGE>

<TABLE>
<CAPTION>
                                                                              As of December 31,
                                                               -----------------------------------------------
                                                                 1998      1999      2000      2001      2002
                                                               -------   -------   -------   -------   -------
                                                                                (in thousands)
<S>                                                            <C>       <C>       <C>       <C>       <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents (including
   short and long-term bank deposits) ......................   $13,320   $12,559   $14,792   $14,587   $14,876
Working capital ............................................    18,832    15,520    20,288    18,391    15,827
Total assets ...............................................    43,579    43,178    48,867    53,347    59,741
Short-term bank credit (including current maturities of
   long-term loans) ........................................     5,558     7,199     2,765     6,264    10,357
Long-term loans ............................................     3,381       193     6,302     5,038     4,698
Total shareholders' equity .................................    27,186    28,874    30,899    32,700    35,031
</TABLE>

B. Capitalization and Indebtedness.

      Not applicable

C. Reasons for the Offer and Use of Proceeds.

      Not applicable.

D. Risk Factors.

      Our business, results of operations and financial condition could be
seriously harmed due to any of the following risks, among others. If we do not
successfully address the risks to which we are subject, our business, results of
operations and financial condition may be materially and adversely affected and
our share price may decline.

Risks Related to our Business

Sales of our products are dependent on government procurement procedures and
practices. A substantial decrease in our customers' budgets would adversely
affect our results of operations.

      Our perimeter security systems and security management systems are
primarily sold to government agencies, government authorities and
government-owned companies, many of which have complex and time-consuming
procurement procedures. A substantial period of time often elapses from the time
we begin marketing a product until we actually sell that product to a particular
customer. In addition, our sales to government agencies, authorities and
companies are directly affected by these customers' budgetary constraints and
the priority given in their budgets to the procurement of our products. A
substantial decrease in our governmental customers' budgets would adversely
affect our results of operations.

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

      Due to the nature of our customers and products, we receive relatively
large orders for our products from a relatively small number of customers.
Consequently, individual orders from individual customers can represent a
substantial portion of our sales in any one period and significant orders by any
customer during one period may not be followed by further orders from the same
customer in subsequent periods. In addition, we have a limited order backlog,
which makes revenues in any quarter substantially dependent upon orders we
deliver in that quarter.


                                       2
<PAGE>

Our sales and operating results are subject to very substantial variations.
Because our quarterly performance is likely to vary significantly, the results
of our operations for any quarter are not necessarily indicative of the results
that we might achieve for any subsequent period. Consequently,
quarter-to-quarter comparisons of our operating results may not be meaningful.

The loss of one or more of our key customers would result in a loss of a
significant amount of our revenues.

      Relatively few customers account for a large percentage of our revenues.
For the years ended December 31, 2000, 2001 and 2002, revenues generated from
sales to the Israeli Ministry of Defense, or MOD, and the Israeli Defense
Forces, or IDF, together accounted for 24.4%, 22.5% and 15.9%, respectively, of
our revenues. For the years ended December 31, 2000, 2001 and 2002 revenues
generated from sales to Azerbaijani Airlines, or Azal, accounted for 2.0%, 10.5%
and 1.8%, respectively of our revenues. We cannot assure you that the MOD, IDF,
Azal or any of our other major customers will maintain their volume of business
with us or that, if such volume is reduced, other customers of similar volume
will replace the lost business. The loss of one or more of these existing
customers without replacement by a customer or customers of similar volume would
have a material adverse effect on our financial results.

In 2001, we established Smart Interactive Systems, Inc. to meet the growing need
for real-time video monitoring services. No assurance can be given that this
company will be successful in the future. If this company is unsuccessful, our
future results of operations may be adversely affected.

      In 2001, we established Smart Interactive Systems, Inc. to meet the
growing demand for real-time video monitoring services for use in industrial
sites, commercial businesses and VIP residences. We have invested $2.8 million
in Smart Interactive Systems through December 31, 2002. Its operations to date
have not been profitable and it has an accumulated deficit of $2.2 million as of
December, 31, 2002. Smart Interactive Systems' success will be dependent upon
its ability to penetrate the market for these services and upon customers'
acceptance of these services. If Smart Interactive Systems is unable to market
its services or if its services are not accepted by customers, we may lose our
investment in this company and our future results of operations may be adversely
affected.

If we do not receive the government approvals necessary for us to export the
products we produce in Israel, our revenues may decrease.

      Under Israeli law, the export of products that we manufacture in Israel
and/or certain know-how is subject to approval by the MOD. We must obtain
permits from the MOD to initiate sales proposals with regard to these exports,
as well as for actual export transactions. We cannot assure you that we will
receive all the required permits for which we may apply in the future. If we do
not receive the required permits for which we apply, our revenues may decrease.

The market for our products is characterized by changing technology,
requirements, standards and products, and we may be adversely affected if we do
not respond promptly and effectively to these changes.

      The market for our products is characterized by evolving technologies,
changing industry standards, changing regulatory environments, frequent new
product introductions and rapid changes in customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards and practices can render existing products obsolete and
unmarketable. Our future success will depend on our ability to enhance our
existing products and to develop and introduce, on a timely and cost-effective
basis, new products and product


                                       3
<PAGE>

features that keep pace with technological developments and emerging industry
standards and address the increasingly sophisticated needs of our customers. We
cannot assure you that:

o     we will be successful in developing and marketing new products or product
      features that respond to technological change or evolving industry
      standards;

o     we will not experience difficulties that could delay or prevent the
      successful development, introduction and marketing of these new products
      and features; or

o     our new products and product features will adequately meet the
      requirements of the marketplace and achieve market acceptance.

We face risks associated with doing business in international markets.

      We make a large portion of our sales in markets outside of Israel and a
key component of our strategy is to continue to expand in such markets, the most
significant of which currently are the U.S., Europe, Azerbaijan and Asia. Our
international sales efforts are affected by costs associated with the shipping
of our products and risks inherent in doing business in international markets,
including:

o     unexpected changes in regulatory requirements;

o     currency fluctuations;

o     export restrictions, tariffs and other trade barriers;

o     difficulties in staffing and managing foreign operations;

o     longer payment cycles;

o     difficulties in collecting accounts receivable;

o     political instability; and

o     seasonal reductions in business activities.

One or more of such factors may have a material adverse effect on us.

We are engaged in a highly competitive business. If we are unable to compete
effectively, sales of our products will be materially and adversely affected.

      The business in which we are engaged is highly competitive. Some of our
competitors and potential competitors have greater research and development,
financial and personnel resources, including governmental support, or more
extensive business experience than we do. If we are unable to compete
effectively in the market for our products, sales of our products will be
materially and adversely affected.

We may not be able to implement our growth strategy.

      As part of our growth strategy, we seek to acquire or invest in
complementary, including competitive, businesses, products and technologies.
Although we have identified potential acquisition candidates, we currently have
no commitments or agreements with respect to any such acquisitions or
investments and we cannot assure you that we will eventually be able to


                                       4
<PAGE>

consummate any acquisition or investment. Even if we do acquire or invest in
these businesses, products or technology, the process of integrating acquired
assets into our operations may result in unforeseen operating difficulties and
expenditures and may absorb significant management attention that would
otherwise be available for the ongoing development of our business. In addition,
we have limited experience in performing acquisitions and managing growth. We
cannot assure you that the anticipated benefits of any acquisition will be
realized. In addition, future acquisitions by us could result in potentially
dilutive issuances of our equity securities, the incurrence of debt and
contingent liabilities and amortization expenses related to goodwill and other
intangible assets, any of which could materially adversely affect our operating
results and financial position. Acquisitions also involve other risks, including
risks inherent in entering markets in which we have no or limited prior
experience and the potential loss of key employees and the risk that we may
experience difficulty or delays in obtaining necessary permits.

We may not be able to protect our proprietary technology and unauthorized use of
our proprietary technology by third parties may impair our ability to compete
effectively.

      Our success and ability to compete depend in large part upon protecting
our proprietary technology. We have 30 patents and have patent applications
pending. We also rely on a combination of trade secret and copyright law and
confidentiality, non-disclosure and assignment-of-inventions agreements to
protect our proprietary technology. It is our policy to protect our proprietary
rights in our products and operations through contractual obligations, including
confidentiality and non-disclosure agreements with certain employees and
distributors. These measures may not be adequate to protect our technology from
third-party infringement, and our competitors may independently develop
technologies that are substantially equivalent or superior to ours.
Additionally, our products may be sold in foreign countries that provide less
protection to intellectual property than that provided under U.S. or Israeli
laws.

We could become subject to litigation regarding intellectual property rights,
which could seriously harm our business.

      Third parties may in the future assert against us infringement claims or
claims that we have violated a patent or infringed upon a copyright, trademark
or other proprietary right belonging to them. In addition, we purchase
components for our turnkey products from independent suppliers. Certain of these
components contain proprietary intellectual property of these independent
suppliers. Third parties may in the future assert claims against our suppliers
that such suppliers have violated a patent or infringed upon a copyright,
trademark or other proprietary right belonging to them. If such infringement by
our suppliers or us were found to exist, a party could seek an injunction
preventing the use of their intellectual property. In addition, if an
infringement by us were found to exist, we may attempt to acquire a license or
right to use such technology or intellectual property. Any infringement claim,
even if not meritorious, could result in the expenditure of significant
financial and managerial resources.

We depend on limited sources for components and if we are unable to obtain these
components when needed, we will experience delays in manufacturing our products
and our financial results may be adversely affected.

      We acquire most of the components utilized in our products, including, but
not limited to, our turnkey products and certain services from a limited number
of suppliers and subcontractors, most of whom are located in Israel. Certain of
these suppliers are currently the sole source of one or more items upon which we
are dependent. We cannot assure you that we will continue to be able to obtain
such items from these suppliers on satisfactory terms. Temporary disruptions of
our manufacturing operations would result if we were required to obtain
materials from alternative sources, which may have an adverse effect on our
financial results. For example, our


                                       5
<PAGE>

subsidiary Senstar-Stellar Corporation, or Senstar, obtains triboelectric sensor
cable for its Intelli-FLEX product from a sole supplier. If this sole supplier
were to discontinue production of the triboelectric sensor cable, it would
adversely affect Senstar's sales of its Intelli-FLEX product.

Undetected defects in our products may increase our costs and impair the market
acceptance of our products.

      The development, enhancement and implementation of our complex systems
entail substantial risks of product defects or failures. We cannot assure you
that, despite testing by us and our customers, errors will not be found in
existing or new products, resulting in delay or loss of revenues, warranty
expense, loss of market share or failure to achieve market acceptance, or
otherwise adversely affecting our business, financial condition and results of
operations. Moreover, the complexities involved in implementing our systems
entail additional risks of performance failures. We cannot assure you that we
will not encounter substantial delays or other difficulties due to such
complexities. Any such occurrence could have a material adverse effect upon our
business, financial condition and results of operations. In addition, the
potential harm to our reputation that may result from product defects or
implementation errors could be damaging to us.

Volatility of the market price of our ordinary shares could adversely affect our
shareholders and us.

      The market price of our ordinary shares has been, and is likely to be,
highly volatile and could be subject to wide fluctuations in response to
numerous factors, including the following:

o     political, economic and other developments in the State of Israel;

o     terrorist attacks and other acts of war, and any response to them;

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

o     announcements by us or our competitors of technological innovations or new
      and enhanced products;

o     developments or disputes concerning proprietary rights;

o     introduction and adoption of new industry standards;

o     changes in financial estimates by securities analysts;

o     market conditions or trends in our industry;

o     changes in the market valuations of our competitors;

o     announcements by us or our competitors of significant acquisitions;

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

o     additions or departures of key personnel.


                                       6
<PAGE>

      In addition, the stock market in general, and the market for Israeli
companies in particular, has been highly volatile. Many of these factors are
beyond our control and may materially adversely affect the market price of our
ordinary shares, regardless of our performance.

We are controlled by Mira Mag Inc. and IAI, who, in the aggregate, beneficially
own 54.3% of our ordinary shares and may therefore be able to elect all of our
directors and exercise control over the outcome of matters requiring shareholder
approval.

      Mira Mag Inc. and IAI, in the aggregate, beneficially own 54.3% of our
outstanding ordinary shares. Mira Mag and IAI have entered into an agreement
regarding, among other things, the election of our directors and granting first
refusal rights on future sales of our ordinary shares. Our articles of
association do not provide for cumulative voting rights for the election of
directors. As a result, so long as Mira Mag and IAI control more than 50% of the
voting rights attached to the ordinary shares represented at a general meeting
of our shareholders, they will be able to elect all of our directors, except our
external directors, and thus control our business, policies and affairs.

If we are characterized as a passive foreign investment company, our U.S.
shareholders may suffer adverse tax consequences, including higher tax rates and
potentially punitive interest charges on the proceeds of sales of our ordinary
shares.

      Generally, we may be characterized as a passive foreign investment company
for U.S. federal income tax purposes if for any taxable year 75% or more of our
gross income is passive income, or 50% or more of our assets are held for the
production of, or produce, passive income. If we are characterized as a passive
foreign investment company, our U.S. shareholders may suffer adverse tax
consequences. These consequences may include having gains realized on the sale
of our ordinary shares treated as ordinary income rather than capital gain
income and having potentially punitive interest charges apply to the proceeds of
sales of our ordinary shares. For a discussion on the consequences of being
classified as a passive foreign investment company, see Item 10.E. "Additional
Information-Taxation-Tax Consequences If We Are a Passive Foreign Investment
Company" below. We believe that we were not a passive foreign investment company
in 2002 and will not be a passive foreign investment company in 2003. However,
the tests for determining passive foreign investment company status are applied
annually and it is difficult to make accurate predictions of future income and
assets, which are relevant to this determination.

We are dependent on our senior management and key personnel, particularly Jacob
Even-Ezra, our chairman and chief executive officer, and Izhar Dekel, our
president, the loss of whom would negatively affect our business.

      Our future success depends in large part on the continued services of our
senior management and key personnel. In particular, we are dependent on the
services of Jacob Even-Ezra, our chairman and chief executive officer, and Izhar
Dekel, our president. We carry key person life insurance for Jacob Even-Ezra and
for Izhar Dekel. Any loss of the services of Jacob Even-Ezra, Izhar Dekel, other
members of senior management or other key personnel would negatively affect our
business.

Our failure to retain and attract personnel could harm our business, operations
and product development efforts.

      Our products require sophisticated research and development, marketing and
sales and technical customer support. Our success depends on our ability to
attract, train and retain qualified research and development, marketing and
sales and technical customer support


                                       7
<PAGE>

personnel. Competition for personnel in all of these areas is intense and we may
not be able to hire sufficient personnel to achieve our goals or support the
anticipated growth in our business. If we fail to attract and retain qualified
personnel, our business, operations and product development efforts would
suffer.

Our non-competition agreements with our key employees may not be enforceable. If
any of these employees leaves us and joins a competitor, our competitor could
benefit from the expertise that our former employee gained while working for us.

      We currently have non-competition agreements with all of our key employees
in Israel. These agreements prohibit these key employees from directly competing
with us or working with our competitors in the event such key employees cease to
work for us. Under current U.S. and Israeli law, we may not be able to enforce
these non-competition agreements. If we are unable to enforce any of these
agreements, our competitors that employ these former employees could benefit
from the expertise these former employees gained while working for us. In
addition, we do not have non-competition agreements with our U.S. employees.

Risk Relating to Our Location in Israel

Conducting business in Israel entails special risks.

      We are incorporated under Israeli law and our principal offices and
manufacturing and research and development facilities are located in the State
of Israel. Political, economic and military conditions in Israel directly affect
our operations. We could be adversely affected by hostilities involving Israel,
the interruption or curtailment of trade between Israel and its trading
partners, or a significant downturn in the economic or financial condition of
Israel.

      Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, and the
continued state of hostility, varying in degree and intensity, has led to
security and economic problems for Israel. Since September 2000, there has been
significant increase in violence, primarily in the West Bank and Gaza Strip, and
the peace process between the parties has stagnated. Since the beginning of 2002
there has been a marked acceleration in the number and frequency of hostile
incidents, including numerous lethal suicide attacks within the Israeli borders.
In response, the Israeli army has made incursions into Palestinian controlled
cities, towns and refugee camps. As a result of the hostilities between Israel
and the Palestinian Authority, most Arab countries with which Israel had
commercial and trading agreements have publicly announced the halt of these
agreements. We could be negatively affected by adverse developments in the
relationship between Israel and the Palestinian Authority, including the recent
violence, or by restrictive laws or practices directed towards Israel or
companies having operations in Israel.

      Most of our employees in Israel are subject to being called upon to
perform military service in Israel, and their absence may have an adverse effect
upon our operations. Generally, unless exempt, male adult citizens and permanent
residents of Israel under the age of 54 are obligated to perform up to 36 days
of military reserve duty annually and all such residents are subject to being
called to active duty at any time under emergency circumstances. We cannot
assess the potential impact of this obligations on our business. In addition,
due to the hostilities between the State of Israel and the Palestinian
Authority, the Israeli Ministry of Defense, or MOD, has issued emergency orders
during 2002 to recruit a large number of reserve soldiers and may issue similar
orders in the future. Any further escalation of the hostilities between Israel
and the Palestinian Authority into a full-scale conflict might require more
significant military reserve service by some of our employees, which may have a
material adverse effect on our business.


                                       8
<PAGE>

Economic conditions in Israel have deteriorated.

      As a result of political instability, the increased level of hostilities
with the Palestinian Authority and the world-wide economic crisis in the hi-tech
and communication industries during 2001 and 2002, the Israeli rate of economic
growth has deteriorated, the Israeli currency has been devaluated and the rate
of inflation has increased. The Israeli Government has proposed certain
budgetary cuts and other changes which were recently adopted by the Israeli
Parliament. However, the impact on the Israeli economy of these and other
measures that may eventually be adopted is uncertain. In addition, certain
credit agencies have stated that they are reviewing Israel's credit rating.
Should such agencies lower Israel's credit rating, the ability of the Israeli
government to generate foreign financial and economic assistance may be
adversely affected. Further, as a result of the above, the Israeli banks have
increased the interest rates on US dollar denominated loans. We cannot assure
you that the Israeli government will be successful in its attempts to stabilize
the Israeli economy or to maintain Israel's current credit rating. Economic
decline as well as price, exchange rate instability and interest rate increases
may have a material adverse effect on us.

We may be adversely affected if the rate of inflation in Israel exceeds the rate
of devaluation of the New Israeli Shekel against the dollar.

      A portion of our expenses, primarily labor expenses, is incurred in NIS.
As a result, we are exposed to the risk that the rate of inflation in Israel
will exceed the rate of devaluation of the NIS in relation to the dollar or that
the timing of this devaluation will lag behind inflation in Israel. Although in
1998 the rate of devaluation of the NIS against the dollar exceeded the rate of
inflation in Israel, a reversal from prior years which benefited us, in 1999,
2000, 2001 and 2002, the inflation rate in Israel exceeded the rate of
devaluation of the NIS against the dollar. Since the beginning of 2003, the NIS
has increased approximately 8.1% against the dollar. In addition, since part of
our sales are quoted in NIS, and a portion of our expenses are incurred in NIS,
our results may be adversely affected by a change in the rate of inflation in
Israel if the amount of our revenues in NIS decreases and is less than the
amount of our expenses in NIS (or if such decrease is offset on a lagging basis)
or if such change in the rate of inflation is not offset, or is offset on a
lagging basis, by a corresponding devaluation of the NIS against the dollar and
other foreign currencies.

      If the rate of inflation in Israel exceeds the rate of devaluation of the
NIS in relation to the dollar or the timing of this devaluation lags behind
inflation in Israel our expenses in NIS in relation to the dollar will increase
and our operating results may be adversely affected.

We may be adversely affected by the recent tax reform in Israel.

      On January 1, 2003, a comprehensive tax reform took effect in Israel.
Pursuant to the reform, resident companies are subject to Israeli tax on income
accrued or derived in Israel or abroad. In addition, the concept of "controlled
foreign corporation" was introduced according to which an Israeli company may
become subject to Israeli taxes on certain income of a non-Israeli subsidiary if
the subsidiary's primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.

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

      We currently receive grants and tax benefits under Government of Israel
programs. In order to maintain our eligibility for these programs and benefits,
we must continue to meet


                                       9
<PAGE>

specified conditions, including, but not limited to, making specified
investments in fixed assets and paying royalties with respect to grants
received. In addition, some of these programs restrict our ability to
manufacture particular products or transfer particular technology outside of
Israel. If we fail to comply with these conditions in the future, the benefits
we receive could be canceled and we could be required to refund any payments
previously received under these programs or pay increased taxes or royalties.
The Government of Israel has reduced the benefits available under these programs
in recent years and these programs and benefits may be discontinued or curtailed
in the future. If the Government of Israel ends these programs and benefits, our
business, financial condition, results of operations and net income could be
materially adversely affected.

The tax benefits that we currently receive from our approved enterprise programs
require us to satisfy specified conditions. If we fail to satisfy these
conditions, we may be required to pay additional taxes and would likely be
denied these benefits in the future.

      The Investment Center of the Ministry of Industry and Trade of the State
of Israel has granted approved enterprise status to certain of our manufacturing
facilities. Starting from when we begin to generate net income from these
approved enterprise programs, any portion of our income derived from these
approved enterprise programs will be exempt from tax for a period of two to four
years and will be subject to a reduced tax for an additional five to eight
years, depending on the percentage of our share capital held by non-Israeli
citizens. The benefits available to our approved enterprise programs are
dependent upon the fulfillment of conditions stipulated in applicable law and in
each program's certificate of approval. If we fail to comply with these
conditions, in whole or in part, we may be required to pay additional taxes for
the period in which we benefited from the tax exemption or reduced tax rates and
would likely be denied these benefits in the future.

Provisions of Israeli law may delay, prevent or make difficult a merger or an
acquisition of us, which could prevent a change of control and therefore depress
the price of our ordinary shares.

      Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making more difficult a merger or other acquisition of
us. The Israeli Companies Law, 5739-1999, known as the Companies Law, generally
requires that a merger be approved by a company's board of directors and by
shareholder vote at a shareholders' meeting that has been called on at least 21
days' advance notice. Any creditor of a merging party may seek a court order
blocking the merger if there is a reasonable concern that the surviving company
will not be able to satisfy all of the obligations of any party to the merger.
Moreover, a merger may not be completed until at least 70 days have passed from
the time that the merger proposal was filed with the Israeli Registrar of
Companies.

      Other potential means of acquiring a public Israeli company might involve
significant obstacles, such as a requirement for court approval for the
acquisition. In addition, a body of case law has not yet developed with respect
to the Companies Law. Until this happens, uncertainties will exist regarding its
interpretation.

      Israeli tax law treats some acquisitions, such as stock-for-stock
exchanges between an Israeli company and a foreign company, less favorably than
do U.S. tax laws. For example, Israeli tax law may subject a shareholder who
exchanges our ordinary shares for shares in another corporation to immediate
taxation. These provisions of Israeli corporate and tax law and the
uncertainties surrounding such law may delay, prevent or make more difficult a
merger or acquisition involving our company. This could prevent a change of
control in our company and limit a shareholder's ability to receive a premium in
a change of control transaction.


                                       10
<PAGE>

ITEM 4. Information on the Company

A. History and Development of the Company.

      We were incorporated under the laws of the State of Israel on March 27,
1984 under the name Magal Security Systems Ltd. We are a public limited
liability company under the Israeli Companies Law, 5739-1999 and operate under
this law and associated legislation. Our principal executive offices and primary
manufacturing and research and development facilities are located near Tel Aviv,
Israel, in the Yahud Industrial Zone. Our mailing address is P.O. Box 70,
Industrial Zone, Yahud 56100, Israel and our telephone number is 972-3-539-1444.
Our agent for service of process in the U.S. is Senstar-Stellar Inc., 43184
Osgood Road, Fremont, CA, 94539. Our address on the Internet is
www.magal-ssl.com. The information on our website is not incorporated by
referance into this annual report.

      We develop, manufacture, market and sell complex computerized security
systems, including a line of perimeter security systems, a video motion
detection system and a security management system and provides video monitoring
services.

      Our predecessor commenced operations in 1969 as a department specializing
in perimeter security systems within the electronics division of Israel Aircraft
Industries Ltd., or IAI, one of Israel's largest industrial companies. Effective
April 1984, we purchased from IAI substantially all of the assets, and assumed
substantially all of the related liabilities, of that department. In 1987, we
acquired a taut wire perimeter intrusion detection line from a competitor.

      In March 1993, we completed an initial public offering of 1,380,000 of our
ordinary shares and in February 1997, we completed a follow-on offering of an
additional 2,085,000 ordinary shares. Our ordinary shares are traded on the
Nasdaq National Market and on the Tel Aviv Stock Exchange under the symbol MAGS.

      In May 1993, Stellar Security Products Inc., or SSP, our indirect
wholly-owned California subsidiary, acquired certain operating assets from, and
assumed certain liabilities of, a California-based subsidiary of the Wackenhut
Corporation. SSP was engaged primarily in the development, manufacture and
marketing of outdoor perimeter security systems, complementary to the security
systems we manufactured.

      Effective as of January 1, 1997, we purchased all of the outstanding
shares of Senstar Corporation, a leading supplier of outdoor perimeter intrusion
detection devices for commercial, governmental, military, correctional and
residential applications, from a subsidiary of Daimler-Benz. We also acquired
the assets and activities comprising the civil security systems business of
Dornier GmbH, an indirect wholly-owned German subsidiary of Daimler-Benz,
responsible for the sale and servicing of Senstar products in Europe as well as
certain related research and development activities. The acquisitions of Senstar
and of the various Dornier businesses are collectively referred to in this
annual report as the Senstar acquisition. Following the consummation of the
Senstar acquisition, SSP changed its name to Senstar-Stellar, Inc., or SSI, and
Senstar Corporation changed its name to Senstar-Stellar Corporation, or Senstar.
We transferred the business we acquired from Dornier to Senstar GmbH, our
newly-formed indirect wholly-owned subsidiary.

      Effective as of September 1, 1997, we purchased substantially all of the
assets and business and assumed certain liabilities of Perimeter Products, Inc.,
or PPI. PPI designs, develops, manufactures and markets perimeter security
systems.


                                       11
<PAGE>

      In December 1999, PPI acquired certain assets of Racon Inc. for
approximately $423,000. Racon manufactures sensors for outdoor intrusion
detection systems utilizing microwave technology.

      In 2001, we established Smart Interactive Systems to meet the growing need
for real-time video monitoring security services in commercial locations. In
2002 Smart Interactive Systems initiated its first efforts to penetrate this
market.

      For a discussion of our capital expenditures and divestitures, see Item
5.B. "Operating and Financial Review and Prospects-Liquidity and Capital
Resources."

B. Business Overview.

General

      We develop, manufacture, market and sell complex computerized security
systems, including:

o     a line of perimeter security systems and a video motion detection system,
      which automatically detect and locate intruders and identify the nature of
      intrusions; and

o     MagNet, a security management system that integrates the management,
      control and display of various security systems into a single, real-time
      database.

      We also provide video monitoring services.

      Our systems are used in more than 70 countries to protect aircraft,
national borders and sensitive facilities, including military bases, power plant
installations, airports, postal facilities, prisons and industrial locations,
from terrorism, theft and other security threats.

Industry Background

      Perimeter Security and Video Motion Detection Systems

      Perimeter security systems enable customers to monitor, limit and control
access by unauthorized personnel to specific regions or areas. High-end
perimeter systems are sophisticated in nature and are used by correctional
facilities, military installations, power companies and other high-security
installations. We believe that we are a leading provider of security systems and
maintenance in this industry.

      Security Management Systems

      The deployment of multiple security systems creates the need for a system
that can manage and control these systems through a single database. In response
to this need, we offer MagNet, a security management system that integrates the
management, control and display of various security systems, both outdoor, such
as perimeter security systems, and indoor, such as fire detection, entry
monitoring and alarm systems, into a single, real-time database.

      Video Monitoring Services

      The rapid consolidation of some of the largest companies in the electronic
security services industry combined with their overall emphasis on residential
security has led to fewer providers of high quality, innovative commercial
electronic security services. We believe that the


                                       12
<PAGE>

potential market for commercial real-time video monitoring security services is
large and that within a few years most of the security systems used at
industrial and commercial sites will adopt video monitoring systems as the
preferred method of surveillance and protection. Consequently, in 2001, we
established Smart Interactive Systems to provide commercial real-time video
monitoring security services.

Business and Marketing Strategy

      Our primary objective is to become a leading provider of security systems
worldwide. To achieve this objective, we have implemented a business strategy
incorporating the following key elements:

      Refine and Broaden Product Line. We have identified the security needs of
our customers and intend to develop new products to meet those needs. We also
intend to continue to focus on improving the sensitivity, detection ability and
reliability of our products. During 2002, we invested 7% of our revenues in
developing new products, expanding the capabilities of existing products and
making custom enhancements for specific projects.

      Enter New Markets and Strengthen Presence in Existing Markets. We intend
to penetrate new geographic markets by various means, including the
establishment of alliances with local distributors. As part of this effort we
entered into a new market in Romania, and signed a contract to protect the
Otopeni International Airport in Bucharest. In connection with this transaction
we established a new subsidiary in Romania. We also intend to increase our
marketing efforts in our existing markets and to acquire or invest in
complementary, including competitive, businesses, products and technologies.

      Leverage Existing Customer Base; Cross-Market Products. We believe that we
have the capability to offer certain of our customers a comprehensive security
package. As part of our product development process, we seek to maintain close
relationships with our customers to identify market needs and to define
appropriate product specifications. We intend to expand the depth and breadth of
our existing customer relationships while initiating similar new relationships.

      Offer Comprehensive Turnkey Solutions. By broadening our product range to
include both indoor and outdoor security systems and by developing our MagNet
security management system, we have acquired the ability, and have begun to
offer, comprehensive turnkey security solutions that provide an entire process
of security implementation. These projects entail:

o     in-depth threat analysis;

o     determination of the appropriate hardware and software solutions;

o     training sessions for systems operators; and

o     upon customer approval, integration of the required systems into our
      MagNet security management system.

      We believe that the market for turnkey security solutions presents a
significant opportunity. We intend to place an emphasis on offering these
turnkey solutions in keeping with our objective of becoming a leading provider
of comprehensive security solutions.


                                       13
<PAGE>

Products and Services

      Perimeter Security Systems

      Our line of perimeter security systems consists of the following:

o     taut wire perimeter intrusion detection systems;

o     INNO Fence;

o     vibration detection systems; and

o     field disturbance sensors.

      Our line of perimeter security systems utilizes sophisticated sensor
devices to detect and locate intruders and identify the nature of intrusions.
Our perimeter security systems have been installed along more than 6,000
kilometers of borders and facility boundaries throughout the world, including
more than 600 correctional institutions in the U.S. and additional correctional
institutions in several other countries. In addition, we have installed several
hundred miles of high-security electronic fences along Israel's borders to
assist in preventing unauthorized entry and infiltration. The IDF has tested our
perimeter security products along with those of several of our competitors. Our
system and two competitor's systems were the only systems to pass the IDF's
tests successfully and to be approved by the MOD for participation in the MOD's
bid for perimeter security systems.

      Taut Wire Perimeter Intrusion Detection Systems. Our taut wire systems
consist of wire strung at high tension between anchor posts. Sensor posts are
located at the middle between anchor posts. These sensor posts contain one or
more devices that detect changes in the tension being exerted on and by the taut
wires. Any force applied against these wires, or released from them, as by
cutting, unless within the parameters designed into the sensors themselves or
programmed into the central control units, automatically triggers an alarm.
Thus, we use taut wire fences as both an integral component of an intruder
detection system and as a physical barrier to infiltration.

      The sealed sensors are not affected by radio frequency interference,
climatic or atmospheric conditions, or electrical transients from power lines or
passing vehicles. The sensors self-adjust to, or remain unaffected by, extreme
temperature variations, minor soil movements and other similar environmental
changes that might trigger false alarms in less sophisticated systems. Our taut
wire systems are designed to discriminate automatically between fence tension
changes typically caused by small animals or violent weather and forces more
typically exerted by a human intruder.

      Our taut wire systems offer customers a wide range of installation
options. Sensor posts can be as far as 200 feet apart, with relatively
inexpensive ordinary fence anchor posts between them. These systems may stand
alone, be mounted on a variety of fence posts or added to an existing wall or
other structure, or mounted on short posts, with or without outriggers.

      Taut wire perimeter systems have been approved by various Israeli and U.S.
security and military authorities. We have installed several hundred kilometers
of these fences along Israel's borders to assist in preventing unauthorized
entry and infiltration. Our taut wire systems cost approximately $50-$100 per
meter.


                                       14
<PAGE>

      INNO Fence. The INNO Fence is a perimeter intrusion detection system in
which fiber-optic technology is contained in, and disguised as, an ordinary
decorative fence. The INNO Fence is a high-security product intended for
customers who must balance security concerns and aesthetic considerations. These
customers include private and official residences, embassies and consulates,
commercial locations within industrial areas and cultural and religious
institutions. The INNO Fence system detects intrusions utilizing a fiber-optic
cable sensor located on top of the fence structure beneath the INNO Fence cover.
Optical fibers then transmit detection data to one of our microprocessor-based
control units, which then performs various data analysis and automatic alarm
functions, such as locating the intrusion along the site's perimeter. The INNO
Fence costs approximately $100-$250 per meter.

      Vibration Detection Systems. We offer two types of vibration detection
systems. While less sensitive than taut wire installations, the adaptability of
these systems to a wide range of pre-existing barrier structures makes these
products viable alternatives for cost-conscious customers. Our vibration
detection devices are most effective when installed on common metal fabric
fences, such as chain link or welded mesh. In our BARRICADE 500 model, pairs of
electro-mechanical sensors are attached to fence panels three meters apart on
any of several common types of fence structures. Once attached to the fence,
each sensor detects vibrations in the underlying structures. The sensor system's
built-in electro-mechanical filtering combines with system input from a weather
sensor to minimize the rate of false alarms from wind, hail or other sources of
nuisance vibrations.

      Intelli-FLEX and FPS microprocessor-based triboelectric and piezoelectric
cable fence sensors are vibration sensitive transducers. Both systems detect any
attempt to cut, climb or penetrate the fence and both have microphonic
properties. The microphonic feature permits audio to be used for low-cost alarm
assessment, providing users with an additional tool for determining the nature
of an attempted intrusion. Our vibration detection systems cost between $15-$50
per meter.

      Field Disturbance Sensors. We offer two types of field disturbance
sensors. The Intelli-Field volumetric electronic field disturbance sensor can be
installed outdoors on fences, buildings or as free-standing units. The
Perimitrax buried volumetric field disturbance sensor can be buried in most
types of soil and paved areas and uses "leaky coax" technology to detect
attempted perimeter penetrations. Both systems detect intrusions before the
intruder touches the sensor. The Intelli-Field system costs approximately
$50-$100 per meter and the Perimitrax system costs approximately $70-$100 per
meter.

      Video Motion Detection System

      Our Video Motion Detection System, or DTS, utilizes advanced video image
processing technology to detect, locate and track intruders automatically. The
system, which was introduced in 1993, experiences fewer false alarms than most
competing products because it is able to distinguish automatically between human
and other forms of infiltration.

      DTS is a detection and tracking system that combines our image processing
technology with input from ordinary video surveillance cameras to detect, locate
and track intruders without continuous human monitoring. Our DTS image
processing and graphics overlay cards and software, when installed in
IBM-compatible personal computer, enable that computer to process video signals,
including signals from visible light, infrared and other camera types. Our image
processing software incorporates a learning cycle that permits the system to
analyze the protected area, including such variable features as changing weather
and lighting conditions, to reduce false alarms. A DTS user can program all the
parameters used to define an alarm condition, including, for example, intruder
speed, object size, threat direction and distance traveled. The user can also


                                       15
<PAGE>

designate specific areas within the camera's field of view to be protected. Each
camera in a multiple camera system can be monitored using different parameters.
Parameters can be switched manually, automatically or by external inputs, and
the cameras can be assigned relative priorities for computer monitoring. These
features enable the DTS video motion detection system to identify an intruder
and then track the intruder in real-time on screen and emit an alarm without the
need for continuous human monitoring.

      When DTS detects an intruder, the control computer automatically generates
an alarm and records the first visual frame of the alarm event on its hard disk.
The system's video monitor will then display the intruder's track across the
camera's field of view. The intruder's track can also be recorded on an optional
computer-controlled videocassette recorder or DVR. Each DTS integrated circuit
board can monitor up to four cameras, so that by using eight empty card slots, a
single computer can be equipped to monitor up to thirty-two cameras. The DTS
system costs approximately $10,000 for the first card and tracking graphics
overlay card and $8,000 each for up to seven additional system cards. Elta
Electronics Industries Ltd., a subsidiary of IAI, developed the DTS for us.

      X-Ray Screening and Detection Systems

      Cargo Pallet Screening Machine. We and Rapiscan Security Products Inc., an
unaffiliated manufacturer in the U.S., have jointly developed cargo pallet
screening machines. In 1996, we were awarded a $3.2 million competitive tender
and signed a contract to supply four pallet screening machines to the Customs
Authority in Israel.

      In 1997, Rapiscan received another tender for 16 cargo pallet screening
machines and contracted with us for the installation and maintenance of these
systems. This installation and maintenance amounted to approximately $2,250,000,
or 15% of the approximately $15 million contract price. In 1998, Rapiscan
notified us that it was withdrawing from its agreement with us and has since
filed suit for sums it claims to be entitled to under the agreement, see Item
8.A. "Financial Information-Consolidated Financial Statements and Other
Financial Information-Legal Proceedings."

      Automatic Explosive Device Detection System - AISYS. From 1991 to 2000, we
sold an explosive device detection system, known as AISYS. However, because the
AISYS system was not approved by the FAA, we ceased manufacturing the AISYS
system in 2000. Since 2000, we have not sold any AISYS systems, but have
performed upgrades and maintenance services on systems we had previously sold.

      Security Management System

      MagNet, our security management system, integrates the management, control
and display of various security systems into a single, real-time database.
MagNet, which is based on computer communications and controlled by a unique
server developed by us, converts in real-time data received from field units,
analyzes that data and transmits operational commands accordingly. It also
generates alarms to indicate problems with any connected security system and
provides explanations as to the causes of the alarms. MagNet displays video
pictures of the alarm source, using an advanced video matrix with a
user-friendly interface. The operational commands transmitted by MagNet are
routed back to the field units or to operator workstations which then convert
these commands to visual information and allow the system operator to respond
and influence the system's operation.

      MagNet integrates various detection technologies, including infrared and
microwave, and enables multiple operators to simultaneously control the system.
It can serve and manage


                                       16
<PAGE>

multiple (similar or different) security systems, sensors, detectors and
controllers, and is unaffected by the distance between the various system
components under its control. MagNet can integrate and control both outdoor
security systems and indoor security systems, and its open architecture enables
operation with systems manufactured by other manufacturers as well as those
manufactured by us. Data can be entered into the MagNet system from anywhere in
the world through the Internet, provided appropriate authorization exists. In
addition, MagNet's TCP/IP protocol and Ethernet boards, using the Windows NT
operating system, allow the system to use a wide range of communications media,
such as telephone lines, fiber optics and wireless communication. MagNet
operates with, and can provide solutions for, various types of security
configurations, as well as adaptations for additional and new security systems.

      During 2002, we made major improvements to MagNet as a result of a
security project we carried out for an Indian client. Among the improvements
were:

o     Connection, interfacing and control for Alarm panels used in standard ID
      Contact protocol;

o     Control of compressed video for thousands of sites; and

o     Creating/monitoring and controlling of "Call Center" for audio connection
      between thousands of remote sites.

Video Monitoring Services

      Smart Interactive Systems' video monitoring services integrate sensors and
video cameras located in a protected area that then transmit the visual
information of activity in the area to a central monitoring station for analysis
and response. Smart Interactive Systems' video transmission and interactive
monitoring services provide complete control of remote surveillance systems from
a central location, thus increasing site security while eliminating or reducing
the need for security guards to patrol areas monitored by video equipment. Smart
Interactive Systems' video transmission systems allow a central operator to
remotely control gates and lights, as well as a particular camera's pan, tilt
and zoom functions and allow the operator to communicate with people at a remote
site. The operator can also monitor and shut down malfunctioning equipment from
a central location.

      Smart Interactive Systems provides remote video verification services and
remote video surveillance services. Smart Interactive Systems' verification
systems are activated by an event, such as an illegal entry or tampering with
property. Within seconds of an event being triggered by an intrusion, Smart
Interactive Systems' systems automatically store the video images which are then
sent to a central control room. The use of audio response to an event allows the
control room operator to effectively stop a developing incident by broadcasting
a warning message directed at the intruder. In addition, the control room
operator can replay video images captured before and after the event to verify a
criminal intrusion. Smart Interactive Systems' operators are then able to
respond to the intrusion quickly and effectively by summoning police assistance
or an entity's appropriate internal security response team. Smart Interactive
Systems' central monitoring station is able to provide instantaneous security
responses across the U.S.

      Smart Interactive Systems' surveillance systems also allow active viewing
of an area on a predetermined schedule, at random or on demand. Smart
Interactive Systems' services are designed to provide for ease of connectivity.
All that is needed for connectivity is a regular telephone line or broadband
connectivity. Images are captured by a video camera and are then digitally
compressed prior to being relayed, depending on the user's choice, over a
standard analog or high-quality digital communication line to the central
monitoring location. Hi-speed


                                       17
<PAGE>

digital modems ensure the signal is moved over the communications network
without error. At the receiving end, the output signal is taken and processed
for display on a standard video monitor.

Marketing, Sales and Distribution

      We have marketed our systems primarily to government agencies, government
authorities and government-owned companies. However, the activities of certain
of these government bodies, are increasingly being privatized in jurisdictions
throughout the world. We believe that our reputation as a vendor of
high-security products in one of the world's most security-conscious countries
often provides us and our sales representatives with direct access to senior
government and corporate officials in charge of security matters elsewhere. In
recent years, we began investing resources in the distribution of perimeter
intrusion detection systems to private corporations, specifically high-tech
companies. We attempt to initiate contact with potential customers at trade
shows, where we demonstrate our products and distribute promotional materials.
After initial discussions, we generally seek to provide potential customers with
products on a trial basis or in a small-scale installation. We believe that this
affords prospective purchasers an opportunity to assess our products over a
sustained period of time under realistic conditions. We have sales offices
located in the United Kingdom, Germany, Mexico, the U.S. and China.

      Perimeter Intrusion Detection Systems. We generally sell our perimeter
intrusion detection systems to exclusive distributors for various geographic
territories or for specific projects. These exclusive distributors then resell
these products at prices negotiated with their respective customers. In some
cases, however, we pay commissions on these third-party sales either to the
distributor or to the sales representatives responsible for facilitating the
transaction. In addition to marketing activities, some of our distributors also
provide installation and maintenance services for our products. We currently
sell our perimeter intrusion detection systems to over thirty distributors, who
then resell these systems. We occasionally use agents to find suitable
distributors and pay finders' fees to these agents for their services.

      Since 1988, we have granted an unaffiliated third party the exclusive
right to distribute our taut wire detection systems in the U.S. and Canada. We
may terminate this distributor's exclusivity if the distributor fails to meet
certain minimum purchase requirements and other performance standards.

      Video Motion Detection System, DTS. Since 1993, we have continued to
improve our DTS system to make it more user-friendly and to meet other customer
expectations. We have participated in exhibitions in Europe, South America and
the Far East to promote the DTS system. In the U.S., we distribute the DTS
system through an unaffiliated exclusive distributor who is subject to minimum
purchase requirements.

      Security Management System and Turnkey Projects. Our marketing efforts for
MagNet and its turnkey projects consist of direct contact with potential
customers. We offer the MagNet system primarily as part of comprehensive turnkey
project solutions or, at the customer's preference, as a stand-alone product.

      Video Monitoring Services. Smart Interactive Systems offers its services
mainly to industrial sites, commercial businesses, educational facilities and
VIP residences. Smart Interactive Systems sells its services through its direct
sales force.

      The following table shows the breakdown of our consolidated sales for the
calendar years 2000, 2001 and 2002 by operating segment:

                                       18
<PAGE>

                                                      Year Ended December 31,
                                                   -----------------------------
                                                     2000       2001       2002
                                                   -------    -------    -------
                                                           (In thousands)
Perimeter .....................................    $33,910    $34,893    $36,435
Projects ......................................      3,802      5,004      5,340
Video Monitoring ..............................         --        142        238
Other .........................................        859        981        953
                                                   -------    -------    -------
                                                   $38,571    $41,020    $42,966
                                                   =======    =======    =======

Seasonality

      Our operating results are characterized by a seasonal pattern, with a
higher volume of sales towards the end of the year. This pattern, which is
expected to continue, is mainly due to two factors:

o     our customers are mainly budget-oriented organizations with lengthy
      decision processes which tend to mature late in the year; and

o     due to weather and other conditions, revenues are often postponed from the
      first quarter to subsequent quarters.

      See also Item 3.D. "Key Information-Risk Factors-Sales of our products are
dependent on government procurement procedures and practices," and "-Because we
receive large product orders from a relatively small number of customers, our
sales and operating results are subject to substantial periodic variations."

Customers

      The following table shows the geographical breakdown of our consolidated
sales for the calendar years 2000, 2001 and 2002:

                                                     Year Ended December 31,
                                               ---------------------------------
                                                 2000         2001         2002
                                               -------      -------      -------
                                                         (In thousands)
Israel ..................................      $13,150      $13,135      $11,350
Europe ..................................        6,126        5,420        6,399
U.S. ....................................       10,721       11,358       12,641
Azerbaijan ..............................          789        4,577          756
Canada ..................................        1,860        2,035        4,324
Other ...................................        5,925        4,495        7,496
                                               -------      -------      -------
                                               $38,571      $41,020      $42,966
                                               =======      =======      =======


                                       19
<PAGE>

      For the years ended December 31, 2000, 2001 and 2002, revenues generated
from sales to the MOD and the IDF accounted for 24.4%, 22.5% and 15.9%,
respectively, of our revenues. For the years ended December 31, 2000, 2001 and
2002 revenues generated from sales to Azal accounted for 2%, 10.5% and 1.8%,
respectively, of our revenues (see note 16.b. of the notes to our consolidated
financial statements). We cannot assure you that the MOD, IDF, Azal or any of
our other major customers will maintain their volume of business with us or
that, if such volume is reduced, other customers of similar volume will replace
the lost business. The loss of one or more of these existing customers without
replacement by a customer or customers of similar volume would have a material
adverse effect on our financial results.

      Perimeter Security Systems. Within Israel, we have installed high-security
taut wire electronic fences over several hundred kilometers of Israel's borders.
We have sold a number of our high-security fence systems to protect other
locations in Israel, including Ben-Gurion International Airport, IAI, facilities
of the Israel Electric Company, the Knesset, industrial plants, prisons and
military bases. Outside Israel, our high-security fence systems have been
purchased to protect various sites, including military installations,
refineries, conventional and nuclear power stations, oil tank farms, industrial
facilities, storage areas and warehouses, royal palaces and presidential
residences in various European countries, the U.S., Azerbaijan, Canada, and in
South America and the Far East.

      Currently, airport security activities concentrate almost exclusively on
screening passengers and luggage within the airport terminal in connection with
passenger check-in. We are aware of only a few airports in the world which
currently have high-security perimeter protection systems to prevent
infiltrators from reaching the airport's tarmac from outside. Most of these
airports utilize a system manufactured by us. In marketing our high-security
fence systems, we target authorities responsible for airport security. To date,
we have sold and installed on a trial basis a limited amount of fencing at
certain airports in Israel, Europe, the U.S. and the Far East. We are continuing
to negotiate with authorities in several other countries to install our fences
around airports. However, we cannot assure you that any sales will result from
these negotiations.

      Our high-security fence systems offer prison authorities the opportunity
to address an escape attempt in real-time, rather than at the next roll-call,
which may be several hours after the escape. Our high-security fence systems
have already been installed in prisons in Australia, Europe, Israel, the U.S.
and the Far East.

      The IDF has tested our perimeter security products along with those of
several of our competitors and our system and two competitor's systems were the
only systems to be approved for participation in the MOD's bid for perimeter
security systems. In April and May 2000, the MOD ordered new perimeter security
systems from us for approximately $9 million in the aggregate. We delivered most
of these orders during 2000. In March 2001, we won a $2 million bid of the MOD
to install a new perimeter security system along Israel's borders. In September
2001, we won a $1.4 million bid of the MOD to perform restoration work along the
Gaza Strip border and a $500,000 bid of the MOD to protect the MOD's
headquarters. In July 2002, we received a $1.5 million order from the MOD to
install additional perimeter intrusion detection systems along the Gaza Strip
border.

      In September 2002, we won 80% of the bids published by the MOD for the
installation of intrusion detection systems along the seam line between Israel
and the West Bank. The bids issued by the MOD were for approximately 125
kilometers, or only one third of the total project. To date, we have won bids
having a value of approximately $15 million to install intrusion detection
systems along approximately 100 kilometers. The first stage of this project,
which was


                                       20
<PAGE>

for $2.4 million, was completed during the fourth quarter of 2002. Most of the
remainder of the project is expected to be installed in 2003.

      In January 2002, Senstar received a $1 million contract from Public Works
and Government Services Canada on behalf of Correctional Service Canada to
supply and install over 700 security cameras and video surveillance equipment to
27 correctional facilities across Canada. In April 2002, Senstar signed a second
contract worth approximately $2.2 million to supply and install Senstar's
Perimitrax sensor as part of Correctional Service Canada's overall perimeter
detection security system at nine of its facilities. Senstar will also provide
operational and maintenance training, as well as a quantity of spare parts and
test equipment and integration into the existing perimeter intrusion detection
system integration units. Installations at six sites, valued at approximatly
$1.6 million, were completed during 2002 and the balance of the contract
($600,000) is expected to be completed during 2003.

      In April 2002, we received orders of approximately $750,000 to protect
major sensitive installations in Israel. Revenues from the majority of these
orders was reflected in our 2002 financial results. The orders were for a number
of our security systems, including our vibration intrusion detection system,
video motion detection system, CCTV cameras and other security systems, all
controlled by MagNet, our security management system.

      In July 2002, we received a $850,000 order to protect a major correctional
facility in Southeast Asia. We are acting as a sub-contractor for Megason
Electronics and Tyco, who won the tender for the total protection of this
facility. Our part in this project includes providing Perimeter fencing,
combined with taut wire intrusion detection systems, CCTV cameras and video
motion detection systems.

      In October 2002, we received an order of approximately $250,000 to install
an additional perimeter security system at the International Ben-Gurion Airport.
Pursuant to the order, we will install a DTR-2000 taut wire intrusion detection
system as well as CCTV cameras. For the past 15 years we have been supplying
perimeter intrusion detection systems to protect Ben-Gurion Airport, with
aggregate sales of approximately $2.5 million.

      In December 2002, SSI and Senstar signed contracts to supply perimeter
intrusion detection systems to correctional facilities in Canada and to a prison
in the state of Pennsylvania. The total amount of both contracts is
approximately $2.3 million, of which orders for $500,000 were executed in 2002.
Senstar will design, supply, install and test its Intelli-Flex fence disturbance
systems at twelve Correctional Service Canada institutions located across Canada
and will also provide operational and technical training. The Intelli-FLEX
sensors will be integrated into the existing perimeter intrusion detection
system (PIDS) integration unit. As of June 2003, 95% of this project has been
completed, with the balance anticipated to be completed by March 31, 2004.

      In March 2003, we received a $300,000 order to protect sensitive
installations in Thailand. This order was completed by the end of the first
quarter of 2003.

      Video Motion Detection System, DTS. We are currently focusing our efforts
on attracting customers through upgrading outdoor systems that are currently
installed at prisons, factories, government buildings and other
security-conscious installations. In addition to our traditional customers,
customers of this product include private companies and utilities companies such
as refineries and electric power stations.

      Security Management System and Turnkey Projects. Since its introduction,
we have sold our MagNet security management system to several customers,
including large international high-technology companies in Israel and abroad.


                                       21
<PAGE>

      In December 1999, we signed an approximately $5.7 million agreement
(including interest) with Azal to protect its international airport in
Azerbaijan. We have received $2.8 million in installment payments under this
agreement and will receive the remaining installments according to a
predetermined schedule which ends in December 2004. According to this agreement,
we are scheduled to receive payments of approximately $1.3 million in each of
2003 and 2004 and $176,000 in 2005.

      In March 2000, we received a $2.7 million order to protect a large
industrial facility in India. This order consititued the first stage of a
comprehensive security installation for this facility and included a variety of
our security systems, all controlled by MagNet. During 2000 and 2001, we
received an aggregate of approximately $800,000 in additional orders.

      In May 2002, we received an approximately $4 million order to protect
communication facilities in India. We completed the majority of this order
during 2002, with the associated revenues reflected in our financial results for
the year 2002. In March 2003, we recived a $0.7 million order that constitutes
the second stage of this project, which is expected to be completed by the end
of the second quarter of 2003. These orders, from a large Indian entity,
constitute the first and second stages of a comprehensive security installation
program and follows $3.5 million in orders executed for another company of the
same Indian concern.

      At the end of 2002 we won a bid to protect the Otopeni International
Airport in Bucharest, Romania. The contract totals approximately $16 million and
is expected to be completed by the end of 2004. This turnkey project includes
different types of security systems that will be integrated by MagNet.

      Video Monitoring Services. We have sold our video monitoring services to
banks and various retail operations.

Recent Developments

      During 2002 we devloped a command and control system named "Fortis", a
fully integrated system that supports decision making and wide-area command and
control in real time. The system creates a unified and interactive intelligence
picture by drawing data from all sensors showing the displacement of ground
forces and adding other relevant information such as video from different
sources, auxiliary services an weather conditions. This combined picture,
constantly updated, is sent by central command to all forces in the command
chain and serves as a uniform basis for operational planning and allocation of
tasks. The beta site has been operating successfully since March 2003.

Support and Maintenance

      Our systems are installed by us or by the customer after appropriate
training, depending on the size of the specific project and the location of the
customer's facilities, as well as on the customer's prior experience with our
systems. We generally provide our customers with training on the use and
maintenance of our systems. This training is conducted either on-site or at our
facilities. In addition, some of our local perimeter security systems customers
and all of our local x-ray screening and detection systems customers have signed
maintenance contracts with us. For systems installed outside of Israel,
maintenance is provided by an independent third party, by distributors or by the
end user. We also provide to customers, for a fee, maintenance and support on an
"as needed" basis.

      We require distributors of our high-security fences to purchase a
demonstration kit that includes full-scale models of all of our fence products,
and to send technical personnel to Israel to


                                       22
<PAGE>

participate in courses given by us that focus on the marketing, installation and
servicing of our products.

      Similarly, with regard to our subsidiaries' products, customer personnel
are trained in product installation and maintenance either at the subsidiaries'
facilities or at the customer's facility. Installation supervision and
assistance are sometimes purchased along with the equipment. The life expectancy
of a high-security fence system is approximately ten years. Consequently, many
miles of fence need to be replaced each year.

      During 2002, we derived less than 10% of our total revenues from
maintenance and services. We generally provide a warranty on most of our
products for defects for which we receive notice within 12 months of the
delivery date of the product.

Research and Development; Royalties

      We place considerable emphasis on research and development to improve our
existing products and technology and to develop new products and technology. We
believe that our future success will depend upon our ability to enhance our
existing products and technology and to introduce on a timely basis new
commercially viable products and technology addressing the needs of our
customers. We intend to continue to devote a significant portion of our
personnel and financial resources to research and development. As part of our
product development process, we seek to maintain close relationships with our
customers to identify market needs and to define appropriate product
specifications. Our development activities are a direct result of the input and
guidance we receive from our marketing personnel during our annual meetings with
such personnel. In addition, the heads of research and development for each of
our development centers discussed below meet annually to identify market needs
for new products.

      Our research and development spending during 2000, 2001 and 2002 was
approximately $3,173,000, $3,331,000 and $3,750,000, respectively, of which net
grants from the Office of the Chief Scientist of the Israel Ministry of Industry
and Trade, or the OCS, and investment tax credits, constituted approximately 6%,
8.3% and 16.6% (see note 17a of the notes to our consolidated financial
statements). In addition to our own research and development activities, we also
acquire know-how from external sources. We cannot assure you that any of our
research and development projects will yield profitable results.

      We have the following three development centers, each of which develops
various products and technologies based on its area of expertise:

o     in Israel, we develop a wide range of products including our taut wire,
      mechanical vibration, video and high-end SMS systems;

o     in California, PPI develops our microphonic fence sensors as well as our
      microwave detection, personal alarm and small/medium end control systems;
      and

o     in Canada, Senstar develops our leaky coax radar, triboelectric and
      fiber-optic fence sensors, electrostatic volumetric detection and medium
      to high-end control systems.

      We seek co-financing of our development projects from the OCS, in return
for royalties at the rate of 3% to 4% of sales of products developed with funds
provided, up to a dollar-linked amount equal to 100%-150%, plus interest at the
LIBOR rate, of the grant received for the particular project. The terms of these
grants require that the manufacture of products developed with these grants
occur in Israel and prohibit transferring technology developed pursuant to the


                                       23
<PAGE>

terms of these grants without the prior consent of the Research Committee of the
OCS. We cannot assure you that, if requested, the OCS will grant such consent.
Each application to the OCS is reviewed separately, so we cannot assure you that
the Israeli Government will continue to support our research and development.

The Fund for the Encouragement of Marketing Activities

      The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded us grants for overseas marketing expenses. We are
obligated to pay royalties to this fund at the rate of 3% of the increase in
export sales, up to the amount of the grants we received. To date, we have
received $310,000 in grants from the fund and, during 2001 and 2002, we paid
$104,000 and $53,000 respectively, in royalties to the fund. As of December 31,
2002, we have a remaining contingent obligation to the fund of $153,000.

Backlog

      Backlog represents signed purchase orders deliverable within six months.
As of May 30, 2003, our backlog amounted to approximately $30 million of which
approximately $22 million is expected to be delivered by the end of 2003 and $8
million is expected to be delivered by the end of 2004.

Manufacturing and Supply

      Our manufacturing operations consist of designing and developing our
products, fabricating and assembling components and finished products, quality
control and final testing. Substantially all of our manufacturing operations are
currently performed at our plant in Yahud, Israel. See "Property, Plants and
Equipment" below.

      Although we generally do not rely upon single-source suppliers and
subcontractors for most of the components used in our products, alternative
sources of supply are available and, therefore, we are not dependent upon these
suppliers and subcontractors. We maintain an inventory of systems and spare
parts in order to enable us to overcome potential temporary supply shortages
until an alternate source of supply is available. However, if we were required
for any reason to acquire any materials or services from alternative sources,
delays in the production process may occur.

      Senstar's manufacturing operations are located at its facility in Carp,
Ontario, Canada and consist of design and development, assembly, final testing
and quality control. Senstar uses local subcontractors for making and mounting
its printed circuit board assemblies. The triboelectric sensor cable for
Senstar's Intelli-FLEX product is obtained from a sole supplier. If this sole
supplier were to discontinue production of the triboelectric sensor cable, it
would adversely affect Senstar's sales of its Intelli-FLEX product.

      PPI's manufacturing operations are located at its facility in Fremont,
California and consist of development and design, assembly, quality control and
final testing. PPI uses local subcontractors for making and mounting its printed
circuit board assemblies.

Competition

      The principal factors affecting competition in the market for security
systems are a system's high probability for detection and low probability of
false and nuisance alarms. We believe that a manufacturer's reputation for
reliable equipment is a major competitive advantage, and that such a reputation
will usually be based on the performance of the manufacturer's


                                       24
<PAGE>

installed systems. Additional competitive factors include quality of customer
support, maintenance and price. We believe that we are competitive with respect
to these factors and that we have a good reputation in the markets in which we
compete.

      Several companies, including Elbit Systems Ltd., Elfar Ltd., Rav-Tec Ltd.,
Trans Ltd. and Gal-Dor Ltd. in Israel, and Detektion Security Systems Inc.,
Herras, Pilkington PLC, Del Norte Security, Geoquip Ltd. and Siemens AG outside
of Israel, produce high-security detection systems.

      There are a number of companies that have developed video motion detection
systems, including Geutebruck GmbH, Adpro and Siemens AG.

      We believe that our principal competitors for security management systems
and turnkey project offerings include, among others, Honeywell Inc., Lockheed
Martin Corporation, Raytheon Company, Siemens AG and Dornier.

      We believe that our principal competitors for video monitoring services
are Westec Security, Inc. and InterSTAR Systems, Inc.

      Some of our competitors and potential competitors have greater research,
development, financial and personnel resources, including governmental support,
or more extensive business experience than we do. We cannot assure you that we
will be able to maintain the quality of our products relative to those of our
competitors or continue to develop and market new products effectively.

Intellectual Property Rights

      We have 30 patents issued and patent applications pending in the U.S. and
in several other countries and have obtained licenses to use proprietary
technologies developed by third parties. We cannot assure you:

      o     that patents will be issued from any pending applications, or that
            the claims allowed under any patents will be sufficiently broad to
            protect our technology;

      o     that any patents issued or licensed to us will not be challenged,
            invalidated or circumvented; or

      o     as to the degree or adequacy of protection any patents or patent
            applications may or will afford.

      In addition, we claim proprietary rights in various technologies,
know-how, trade secrets and trademarks relating to our principal products and
operations. We cannot assure you as to the degree of protection these claims may
or will afford. It is our policy to protect our proprietary rights in our
products and operations through contractual obligations, including
confidentiality and non-disclosure agreements with certain employees and
distributors. We cannot assure you as to the degree of protection these
contractual measures may or will afford. Although we are not aware that we are
infringing upon the intellectual property rights of others, we cannot assure you
that an infringement claim will not be asserted against us in the future. We
believe that our success is less dependent on the legal protection that our
patents and other proprietary rights may or will afford than on the knowledge,
ability, experience and technological expertise of our employees. We cannot
provide any assurance that we will be able to protect our proprietary
technology. The unauthorized use of our proprietary technology by third parties
may impair our


                                       25
<PAGE>

ability to compete effectively. We could become subject to litigation regarding
intellectual property rights, which could seriously harm our business.

Government Regulation of Certain Exports

      Under Israeli law, the export of products that we manufacture in Israel
and/or certain know-how is subject to approval by the MOD. We must obtain
permits from the MOD to initiate sales proposals with regard to such exports, as
well as for actual export transactions. We cannot assure you that we will
receive all the required permits for which we may apply in the future.

C. Organizational Structure.

      The table below lists our subsidiaries. Unless otherwise indicated, we, or
one of our subsidiaries, own 100% of the outstanding capital stock of the
subsidiary.

      Name of Subsidiary                          Country of Incorporation
      ------------------                          ------------------------

      Senstar-Stellar Corporation                 Canada

      Perimeter Products Inc.                     United States

      Senstar-Stellar Inc.                        United States

      Senstar GmbH                                Germany

      Kobb Inc.                                   United States

      Magal B.V.                                  The Netherlands

      Senstar-Stellar Latin America S.A. de C.V.  Mexico

      Senstar-Stellar Limited                     United Kingdom

      Smart Interactive Systems, Inc.             United States

      E.S.E. Ltd.                                 Israel

      Magal Security Sisteme S.R.L                Romania (incorporated in April
                                                  2003)

D. Property, Plants and Equipment

      From 1988 to 1990, we built and equipped our current plant at a cost of
approximately $2.8 million. The two-story, 2,533 square meter structure is
located on a 4,352 square meter parcel near Tel Aviv in the Yahud Industrial
Zone. In 1997, we expanded our plant by approximately 500 square meters, at a
cost of approximately $500,000. We purchased the rights to this land in August
1988 from a third party, which had purchased them primarily from the Israel Land
Authority. In accordance with Israeli law, this parcel of land is still
registered in the name of the Israel Land Authority. We will be entitled to have
title to the property recorded in our name when Israeli authorities subdivide
the property into parcels. This procedure is a statutory requirement for
transferring land ownership in Israel. The products that we manufacture at this
facility include our taut-wire intrusion detection systems, our vibration
detection systems,


                                       26
<PAGE>

our video-motion detection systems, INNO Fence, MagNet, various electronic boxes
used in our various systems and other perimeter systems.

      Senstar owns a 33,000 square foot facility in Carp, Ontario, Canada.
Approximately 7,000 square feet are devoted to administrative, marketing and
management functions and approximately 8,000 square feet are used for
engineering, system integration and customer service. Senstar uses the remaining
18,000 square feet for production operations, including cable manufacturing,
assembly, testing, warehousing, shipping and receiving. Senstar also leases ten
acres of land near this facility that is used as an outdoor sensor test and
demonstration sites for its products. The products that Senstar manufactures at
this facility include the Perimitrax/Panther 2000 buried cable intrusion
detection systems, the Intelli-Field electro static detection system, the
Intelli-FLEX microphonic fence detection system and various perimeter monitoring
and control systems.

      In March 2000, PPI purchased a new 20,000 square foot facility in Fremont,
California for approximately $2.9 million and subsequently relocated to this new
facility. The products that PPI manufactures at this facility include
Intelli-Wave, various sensors, the PAS personal alarm system and the MX control
and monitoring center.

      In connection with two of our credit lines, a fixed charge was placed on
our physical plant in Israel by each of Bank Leumi Israel and Union Bank of
Israel, each of which ranks pari-passu with the other. In addition, PPI has
granted its mortgage lender a first mortgage on its premises.

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

ITEM 5. Operating and Financial Review and Prospects

      The following discussion of our results of operations and financial
condition should be read in conjunction with our consolidated financial
statements and the related notes thereto 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.D. "Key
Information-Risk Factors."

      General

      Our financial statements are denominated in dollars, our functional
currency since our incorporation in 1984.

      Following the terrorist attacks of September 11, 2001, heightened global
security concerns have increased the demand for products such as ours, which
protect aircraft, national borders and sensitive facilities from terrorism, and
we have experienced an increase in inquiries from prospective customers
regarding our products. Although we expect demand for our products to increase,
because our products are primarily sold to government agencies, government
authorities and government-owned companies, many of which have complex and
time-consuming procurement procedures, we may not make actual sales of our
products and may not experience an increase in our revenues until, at the
earliest, the end of 2003.

      The continued state of hostility in Israel between Israel and the
Palestinian Authority has caused Israel to increase its efforts to protect its
facilities and installations from unauthorized


                                       27
<PAGE>

intrusions. The Israeli Government has recently announced construction of a
fence to seal off parts of the West Bank to prevent Palestinian terrorists from
entering Israel. In September 2002, we won 80% of the bids published by the MOD
for the installation of intrusion detection systems along the seam line between
Israel and the West Bank. The bids issued by the MOD were for approximately 125
kilometers, or only one third of the total project. To date, we have won bids
having a value of approximately $15 million to install intrusion detection
systems along approximately 100 kilometers. The first stage of this project,
which was for $2.4 million, was completed during the fourth quarter of 2002.
Most of the remainder of the project is expected to be installed in 2003. In
addition, since the MOD and IDF have historically accounted for a significant
amount of our revenues, we believe that if Israel decides to partition
additional parts of its territory we will experience an increase in sales of our
products. However, we cannot assure you that Israel will decide to erect such a
partition, or if such a partition is constructed, that our products will be
utilized in its construction.

      During 2002, we incurred increased expenses relating to the start-up of
the operations of Smart Interactive Systems.

Discussion of Critical Accounting Policies

      The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and the use of different
assumptions would likely result in materially different results of operations.

      Critical accounting policies are those that are both most important to the
portrayal of a company's financial position and results of operations, and
require management's most difficult, subjective or complex judgments. Although
not all of our significant accounting policies require management to make
difficult, subjective or complex judgments or estimates, the following policies
and estimates are those that we deem most critical:

      Revenue Recognition

      We generate revenues mainly from long-term projects and also from sales of
products and rendering maintenance services.

      Revenues from long-term projects are recognized in accordance with
Statement of Position 81-1 "Accounting for Performance of Construction - Type
and Certain Production - Type Contracts" ("SOP 81-1"), using contract accounting
on a percentage of completion method, based on the relationship of actual costs
incurred to total costs estimated to be incurred over the duration of the
contract and in accordance with the "Input Method." Provisions for estimated
losses on uncompleted contracts are made in the period in which such losses are
first determined, in the amount of the estimated loss on the entire contract. As
of December 31, 2002, no such estimated losses were identified.

      Estimated gross profit or loss from long-term contracts may change due to
changes in estimates resulting from differences between actual performance and
original forecasts. Such changes in estimated gross profit are recorded in
results of income when they are reasonably determinable by management, on a
cumulative catch-up basis.

      According to ("SOP 81-1"), costs that are incurred for a specific
anticipated contract are being deferred, subject to evaluation of their probable
recoverability, and only if the costs can be directly associated with a specific
anticipated contract.


                                       28
<PAGE>

      Revenues from product sales are recognized in accordance with Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements", ("SAB
No. 101"), when delivery has occurred, persuasive evidence of an agreement
exists, the vendor's fee is fixed or determinable, no further obligation exists
and collectability is probable.

      Deferred revenue includes unearned amounts received under maintenance
contracts but not yet recognized as revenues.

      Management's judgement is required to determine the percentage of
completion based on the output measure of the portion of work performed, to
match expenses to revenues and to estimate future expenses in order to estimate
the provisions for estimated losses on uncompleted contracts.

      Inventories

      Inventories are stated at the lower of cost or market value. Inventory
write-offs are provided to cover risks arising from slow-moving items,
technological obsolescence, excess inventories, discontinued products, and for
market prices lower than cost. Management's judgment is required to determine
the reserve for obsolete or excess inventory. Inventory on hand may exceed
future demand either because the product is outdated, or obsolete, or because
the amount on hand is more than can be used to meet future need. We provide for
the total value of inventories that we determine to be obsolete based on
criteria such as customer demand and changing technologies.

      Inventory cost is determined as follows:

      o     raw materials, parts and supplies - using the "first in, first out"
            method;

      o     work-in-progress - represents the cost of development in progress;
            and

      o     finished products - on the basis of direct manufacturing cost with
            the addition of allocable indirect manufacturing costs.

      Income taxes

      We account for income taxes in accordance with Statement of Financial
Accounting Standard No. 109 "Accounting for Income Taxes", or SFAS No. 109. This
statement prescribes the use of the liability method whereby deferred tax asset
and liability account balances are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. We provide a valuation allowance, if necessary, to
reduce deferred tax assets to their estimated realizable value.

      As part of the process of preparing our consolidated financial statements,
we are required to estimate our income taxes in each of the jurisdictions in
which we operate. This process involves estimating our actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within our consolidated
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and we must establish a valuation
allowance to reduce its deferred tax assets to the amount that is more likely
than not to be realized. Increases in the valuation allowance result in
additional expense to be reflected within the tax provision in the consolidated
statement of income. At December 31, 2002, our deferred tax asset was $1.1
million.


                                       29
<PAGE>

      Financial statements in dollars

      The dollar is the primary currency of the economic environment in which we
operate. Monetary accounts maintained in currencies other than the dollar are
remeasured into U.S. dollars in accordance with Statement of the Financial
Accounting Standards Board ("FASB") No. 52 "Foreign Currency Translation." All
transaction gains and losses from the remeasured monetary balance sheet items
are reflected in the statement of income as financial income or expenses, as
appropriate.

      The financial statements of certain foreign subsidiaries whose functional
currency is not the dollar, have been translated into U.S. dollars. All balance
sheet accounts have been translated using the exchange rates in effect at the
balance sheet date. Statement of income amounts have been translated using the
average exchange rate for the period. The resulting translation adjustments are
reported as a component of shareholders' equity in accumulated other
comprehensive loss.

      Accordingly, we had cumulative translation losses of approximately $1.0
million and $1.3 million that were included as part of "accumulated other
comprehensive loss" within our balance sheet at December 31, 2002 and 2001,
respectively. During 2002, 2001 and 2000, translation gains (losses) of
$288,000, ($579,000), and ($281,000), respectively, were included under
"accumulated other comprehensive loss." Had we determined that the functional
currency of our subsidiaries was the dollar, these losses would have increased
our loss for each of the years presented.

      Goodwill

      Goodwill represents excess of the costs over the net assets of businesses
acquired. Goodwill arose from acquisitions prior July 1, 2001, was amortized
until December 31, 2001, on a straight-line basis over a period of fifteen
years. Under Statement of Financial Accounting Standard No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No, 142"), goodwill acquired in a business
combination completed on or after July 1, 2001 will not be amortized.

      SFAS No. 142 requires that goodwill be tested for impairment on adoption
and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill attributable to each of the
reporting units is tested for impairment by comparing the fair value of each
reporting unit with its carrying value. Fair value is determined using
discounted cash flows, market multiples and market capitalization. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, weighted average cost of capital
and estimates of market multiples for each of the reportable units.

      SFAS No. 142 prescribes a two-phase process for impairment testing of
goodwill. The first phase screens for impairment; while the second phase (if
necessary) measures the impairment. We completed our first phase impairment
analysis related to the adoption of SFAS 142 during the first quarter of 2002
and our annual impairment test during the fourth quarter of 2002 and found no
instances of impairment of our recorded goodwill; accordingly, the second
testing phase was not necessary. No subsequent indicators of impairment have
been noted by us.

      Concentrations of credit risk

      Financial instruments that potentially subject us and our subsidiaries to
concentrations of credit risk consist principally of cash and cash equivalents,
short and long-term bank deposits, trade receivables and long-term trade
receivables.


                                       30
<PAGE>

      Our cash and cash equivalents, short-term and long-term bank deposits are
invested in major Israeli and U.S. banks. Such deposits in U.S. banks may be in
excess of insured limits and are not insured in other jurisdictions. We believe
that the financial institutions that hold our investments are financially sound
and, accordingly, minimal credit risk exists with respect to these investments.

      The trade receivables of our company and our subsidiaries are derived from
sales to large and solid organizations located mainly in Israel, the United
States, Canada and Europe. We perform ongoing credit evaluations of our
customers and to date have not experienced any material losses. An allowance for
doubtful accounts is determined with respect to those amounts that we have
determined to be doubtful of collection.

      We have no off balance sheet concentration of credit risk such as foreign
exchange contracts option contracts or other foreign hedging arrangements.

Periodic Variations in Operating Results

      Due to the nature of our customers and products, our sales are often made
pursuant to a relatively small number of large orders. Consequently, individual
orders from individual customers can represent a substantial portion of our
sales in any one period and significant orders by any customer during one period
may not be followed by further orders from the same customer in subsequent
periods. Our sales and operating results may, therefore, vary substantially from
period to period. Consequently, we do not believe that our sales and operating
results should necessarily be judged on a quarter-to-quarter comparative basis.

A. Results of Operations

      The following table presents, for the periods indicated, certain financial
data expressed as a percentage of revenues:

<TABLE>
<CAPTION>
                                                              Year Ended December 31,
                                                      -------------------------------------
                                                      1998     1999     2000    2001   2002
                                                      ----     ----     ----    ----   ----
<S>                                                    <C>      <C>      <C>     <C>    <C>
Revenues ..........................................    100%     100%     100%    100%   100%
Cost of revenues ..................................     52       53       53      52     56
                                                      ----     ----     ----     ---    ---
Gross profit ......................................     48       47       47      48     44
                                                      ----     ----     ----     ---    ---
Operating expenses:
   Research and development expenses, net .........      7        8        8       8      7
   Sales and marketing ............................     18       18       18      19     20
   General and administrative .....................     14       13       12      12     11
                                                      ----     ----     ----     ---    ---
Operating income ..................................      9        8        9       9      6
Financial income (expenses), net ..................     (1)      --       (1)     --     --
                                                      ----     ----     ----     ---    ---
Income before taxes on income and
   write-off of investment in affiliate, net of
   taxes ..........................................      8        8        8       9      6
Taxes on income ...................................      1        1        1       1      2
                                                      ----     ----     ----     ---    ---
Income before write-off of investment in
   affiliate ......................................      7        7        7       8      4
Write-off of investment in affiliate, net of
   taxes ..........................................     --       (1)      --      --     --
                                                      ----     ----     ----     ---    ---
Net income ........................................      7%       6%       7%      8%     4%
                                                      ====     ====     ====     ===    ===
</TABLE>


                                       31
<PAGE>

Years ended December 31, 2002 and 2001

      Revenues. Revenues increased by 5% to $43 million in the year ended
December 31, 2002, compared with $41 million in the year ended December 31,
2001. Revenues from sales of perimeter systems in 2002 were $36.4 million
compared to $34.9 million in 2001, an increase of 4%. Revenues from security
turnkey projects increased by 7% to $5.3 million in 2002, compared with $5.0
million in 2001.

      Cost of revenues. Cost of revenues reached $23.9 million in the year ended
December 31, 2002, compared with $21.5 million in the year ended December 31,
2001. Cost of revenues as a percentage of revenues was 56% in 2002, as compared
to 52% in 2001.

      Gross profit. Gross profit for the year ended December 31, 2002 was $19.0
million, compared to $19.5 million for the year ended December 31, 2001. Gross
profit as a percentage of revenues decreased to 44% in 2002, compared with 48%
in 2001.

      Research and development expenses. Net research and development expenses
for the year ended December 31, 2002 were $3.05 million, compared to $3.13
million for the year ended December 31, 2001, an increase of 2%. Net research
and development expenses amounted to 7% of revenues in 2002, compared to 8% in
2001. Research and development grants and investment tax credits increased to
$622,000 in 2002, compared to $277,000 in 2001, due to an increase in grants
received from the Chief Scientist.

      Sales and marketing expenses. Sales and marketing expenses were $8.6
million for the year ended December 31, 2002, compared to $7.9 million for the
year ended December 31, 2001, an increase of 9%. Sales and marketing expenses
amounted to 20% of revenues in 2002, compared with 19% in 2001. The increase in
sales and marketing expenses in 2002 was primarily due to an increase in
commissions resulting from increased sales of products for which we pay
commissions and also due to expenses incurred in connection with establishing
Smart Interactive Systems.

      General and administrative expenses. General and administrative expenses
were $4.9 million for the year ended December 31, 2002, substantially unchanged
from the year ended December 31, 2001. General and administrative expenses
amounted to 11% of revenues in 2002, compared to 12% in 2001.

      Financial income. Financial income for the year ended December 31, 2002
was $199,000 compared to income of $40,000 for the year ended December 31, 2001.

      Net income. As a result of the foregoing, we had net income of $1.9
million in the year ended December 31, 2002, compared to net income of $3.2
million in the year ended December 31, 2001, a decrease of 40%. Our net income
in 2002 was negatively affected by the $1.6 million in losses attributable to
the start-up of operations of Smart Interactive Systems.

Years ended December 31, 2001 and 2000

      Revenues. Revenues increased by 6% to $41.0 million in the year ended
December 31, 2001, compared with $38.6 million in the year ended December 31,
2000. Revenues from sales of perimeter systems in 2001 were $34.9 million
compared to $33.9 million in 2000, an increase of 3%. Revenues from security
turnkey projects increased by 32% to $5.0 million in 2001, compared with $3.8
million in 2000. The increase in our revenues was primarily due to increased
sales to Azal.


                                       32
<PAGE>

      Cost of revenues. Cost of revenues reached $21.5 million in the year ended
December 31, 2001, compared with $20.5 million in the year ended December 31,
2000. Cost of revenues as a percentage of revenues was 52% in 2001, as compared
to 53% in 2000.

      Gross profit. Gross profit in the year ended December 31, 2001 was $19.5
million, compared to $18.0 million the year ended December 31, 2000. Gross
profit as a percentage of revenues increased slightly to 48% in 2001, compared
with 46.8% in 2000.

      Research and development expenses. Net research and development expenses
in the year ended December 31, 2001 were $3.05 million compared to $2.98 million
in the year ended December 31, 2000, an increase of 3%. The increase in our net
research and development expenses was primarily due to an increase in our
research and development staff. Net research and development expenses amounted
to 8% of revenues in 2001, unchanged from 2000. Research and development grants
and investment tax credits were $277,000 in 2001, compared to $198,000 in 2000,
due to an increase in investment tax credits.

      Sales and marketing expenses. Sales and marketing expenses were $7.9
million in the year ended December 31, 2001, compared to $7.1 million in the
year ended December 31, 2000, an increase of 11%. Sales and marketing expenses
amounted to 19% of revenues in 2001, compared with 18% in 2000. The increase in
sales and marketing expenses in 2001 was primarily due to an increase in paid
commissions resulting from increased sales of products for which we pay
commissions and also due to expenses incurred in connection with establishing
Smart Interactive Systems.

      General and administrative expenses. General and administrative expenses
were $4.9 million in the year ended December 31, 2001, compared to $4.7 million
in the year ended December 31, 2000, an increase of 6%. The increase in general
and administrative expenses in 2001 was primarily due to expenses incurred in
connection with establishing Smart Interactive Systems. General and
administrative expenses amounted to 12% of revenues in 2001, unchanged from
2000.

      Financial income (expenses). Financial income was $40,000 in the year
ended December 31, 2001, compared to financial expenses of $214,000 in the year
ended December 31, 2000. The improvement was due to an increase in foreign
exchange gains.

      Net income. Net income was $3.2 million in the year ended December 31,
2001, compared to $2.9 million in the year ended December 31, 2000, an increase
of 10%. Our net income in 2001 was affected by approximately $626,000 of losses
attributable to Smart Interactive Systems.

Seasonality

      Our operating results are characterized by a seasonal pattern, with a
higher volume of sales towards the end of the year. This pattern, which is
expected to continue, is mainly due to two factors:

o     our customers are mainly budget-oriented organizations with lengthy
      decision processes which tend to mature late in the year; and

o     due to weather and other conditions, revenues are often postponed from the
      first quarter to subsequent quarters.


                                       33
<PAGE>

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

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

      In addition, since part of our sales are quoted in NIS, and a portion of
our expenses are incurred in NIS, our results may be adversely affected by a
change in the rate of inflation in Israel if the amount of our revenues in NIS
decreases and is less than the amount of our expenses in NIS (or if such
decrease is offset on a lagging basis) or if such change in the rate of
inflation is not offset, or is offset on a lagging basis, by a corresponding
devaluation of the NIS against the dollar and other foreign currencies.

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

<TABLE>
<CAPTION>
                                                                     Israeli inflation
         Year ended      Israeli inflation       NIS devaluation       adjusted for
        December 31,          rate %                 rate %            devaluation %
        ------------     -----------------       ---------------     -----------------
<S>                              <C>                   <C>                 <C>
            1998                 8.6                   17.6                (9.0)
            1999                 1.3                   (0.2)                1.1
            2000                 0                     (2.7)                2.7
            2001                 1.4                    9.3                (7.9)
            2002                 6.5                    7.3                (0.8)
</TABLE>

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

      Because exchange rates between the NIS and the dollar fluctuate
continuously, with a historically declining trend in the value of the NIS,
exchange rate fluctuations, particularly larger periodic devaluations, may have
an impact on our profitability and period-to-period comparisons of our results.
During 2002, foreign currency fluctuations did not have a material adverse
impact on our results of operations. We cannot assure you that in the future our
results of operations may not be materially adversely affected by currency
fluctuations.

      We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain sales and
purchase transactions. During 2002 we did not enter into any such contracts and
as of December 31, 2002, we had no derivative financial instruments.


                                       34
<PAGE>

Political Conditions

      Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, and the
continued state of hostility, varying in degree and intensity, has led to
security and economic problems for Israel. Since September 2000, there has been
significant increase in violence, primarily in the West Bank and Gaza Strip, and
the peace process between the parties has stagnated. Since the beginning of 2002
there has been a marked acceleration in the number and frequency of hostile
incidents, including numerous lethal suicide attacks within the Israeli borders.
In response, the Israeli army has made incursions into Palestinian controlled
cities, towns and refugee camps.

      Several countries continue to restrict business with Israel and with
companies having operations in Israel. Although we are precluded from marketing
our products to these countries, we believe that in the past these restrictions
have not had a material adverse effect on us. In addition, as a result of the
hostilities between Israel and the Palestinian Authority, most Arab countries
with which Israel had commercial and trading agreements have publicly announced
the halt of these agreements. Also, as a result of the Israeli military
activities in the West Bank during April 2002, several European countries are
considering participating in a boycott of Israeli firms. We do not believe that
these measures will have a material adverse affect on us. However, restrictive
laws, policies or practices directed towards Israel or Israeli businesses could
have an adverse impact on our business.

      In addition, some of our employees in Israel are subject to being called
upon to perform military service in Israel, and their absence may have an
adverse effect upon our operations. Generally, unless exempt, male adult
citizens and permanent residents of Israel under the age of 54 are obligated to
perform up to 36 days of military reserve duty annually and all such residents
are subject to being called to active duty at any time under emergency
circumstances. In addition, due to the hostilities between the State of Israel
and the Palestinian Authority, the MOD has issued emergency orders during 2002
to recruit a large number of reserve soldiers and may issue similar orders in
the future. 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.

      To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further escalation of the
hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.

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. Due to, principally, a continuing budget deficit of the
Israeli government and the slow down of the Israeli economy in recent years, the
Israeli parliament approved, on May 29, 2003, an economic plan that entails,
among other things, budget cuts in various sources of government spending, the
increase of various tax liabilities and cuts in various social benefits. It is
not known at this stage what impact the implementation of the approved economic
plan will have on the Israeli economy.

      As a result of political instability, the increased level of hostilities
with the Palestinian Authority and the world-wide economic crisis in the hi-tech
and communication industries, during 2001 and 2002, the Israeli rate of economic
growth has deteriorated, the NIS has been


                                       35
<PAGE>

devaluated and the rate of inflation has increased. The Israeli Government has
proposed certain budgetary cuts and other changes which were recently adopted by
the Israeli Parliament. However, the impact on the Israeli economy of these and
other measures that may eventually be adopted is uncertain. In addition, certain
credit agencies have stated that they are reviewing Israel's credit rating.
Should such agencies lower Israel's credit rating, the ability of the Israeli
government to generate foreign financial and economical assistance may be
adversely affected. Further, as a result of the above, the Israeli banks have
increased the interest rates on US dollar denominated loans. We cannot assure
you that the Israeli government will be successful in its attempts to stabilize
the Israeli economy or to maintain Israel's current credit rating. Economic
decline as well as price, exchange rate instability and interest rate increases
may have a material adverse effect on us.

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 U.S., Australia, Canada and Japan. These
preferences allow Israel to export products covered by such programs either
duty-free or at reduced tariffs.

      Israel and the European Union Community concluded a Free Trade Agreement
in July 1975 which confers certain advantages on Israeli exports to most
European countries and obligates Israel to lower its tariffs on imports from
these countries over a number of years. In 1985, Israel and the U.S. entered
into an agreement to establish a free trade area. The free trade area has
eliminated all tariff and specified non-tariff barriers on most trade between
the two countries. On January 1, 1993, an agreement between Israel and the
European Free Trade Association, known as EFTA, which includes Austria, Finland,
Iceland, Liechtenstein, Norway, Sweden and Switzerland, established a free-trade
zone between Israel and the EFTA nations. In November 1995, Israel entered into
a new agreement with the European Union, which includes redefinement of rules of
origin and other improvements, including providing for Israel to become a member
of the research and technology programs of the European Union. 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.

Effective Corporate Tax Rate

      Israeli companies are generally subject to tax at the rate of 36% of
taxable income. However, certain of our manufacturing facilities have been
granted "Approved Enterprise" status under the Law for the Encouragement of
Capital Investments, 1959, as amended, commonly referred to as the Investment
Law, and, consequently, are eligible, subject to compliance with specified
requirements, for tax benefits beginning when such facilities first generate
taxable income. The tax benefits under the Investment Law are not available with
respect to income derived from products manufactured outside of Israel. We have
derived, and expect to continue to derive, a substantial portion of our income
from our Approved Enterprise facilities. Subject to certain restrictions, we are
entitled to a tax exemption in respect of income derived from our approved
facilities for a period of two to four years, commencing in the first year in
which such income is earned, and will be entitled to a reduced tax rate of 15%
for an additional eight years if we qualify as a foreign investors' company. If
we do not qualify as a foreign investors' company, we will instead be entitled
to a reduced rate of 25% for an additional five, rather than eight, years.


                                       36
<PAGE>

      Our effective corporate tax rate may substantially exceed the Israeli tax
rate. Our U.S. subsidiaries will generally be subject to applicable federal,
state, local and foreign taxation, and we may also be subject to taxation in the
other foreign jurisdictions in which we own assets, have employees or conduct
activities. Because of the complexity of these local tax provisions, it is not
possible to anticipate the actual combined effective corporate tax rate which
will apply to us.

      As of December 31, 2002, our subsidiaries in the U.S., Latin America and
the United Kingdom had total net available carryforward tax losses of
approximately $3.6 million. Utilization of U.S. net operating losses may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state tax law
provisions. The annual limitation may result in the expiration of net operating
losses before utilization. As of December 31, 2002, net operating losses from
our subsidiaries in U.S. were approximately $ 2.7 million.

Government Grants

      The Government of Israel, through the OCS, encourages research and
development projects which result in products for export. We may receive up to
50% of our research and development expenditures for particular projects from
the OCS. We received grants from the OCS totaling approximately $25,000 in 2000,
$0 in 2001 and $318,000 in 2002. Pursuant to the terms of these grants, we are
obligated to pay royalties of 3% to 4% of revenues derived from sales of
products funded with these grants. In the event that a project funded by the OCS
does not result in the development of a revenue-generating product, we would not
be obligated to repay the grants we received for such product's development. As
of December 31, 2002, our contingent liability to the OCS in respect of grants
received was approximately $1.5 million.

      The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded us grants for overseas marketing expenses. We are
obligated to pay royalties to this fund at the rate of 3% of the increase in
export sales , up to the amount of the grants we received. To date, we received
$310,000 in grants from the fund and, during 2001 and 2002, we paid $104,000 and
$53,000 in royalties to the fund. As of December 31, 2002, we have a remaining
contingent obligation to the fund of $153,000.

Investment tax credit

      Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
2000, 2001 and 2002, Senstar, recognized $173,000, $277,000, and $304,000,
respectively, of investment tax credits as a reduction of research and
development expenses.

      Senstar has available investment tax credits of approximately $618,000 to
reduce future federal income taxes payable. These credits will expire at various
dates from 2006 through 2011.

B. Liquidity and Capital Resources

General

      Our ongoing liquidity requirements arise primarily from our need to
service debt and provide working capital. From our inception until our initial
public offering in March 1993, we financed our activities mainly through cash
flow from operations and bank loans. In March 1993, we raised a net total of
$9,837,000 from an initial public offering of 1,380,000 ordinary shares. In
February 1997, we raised an additional $9,440,000 from an offering of an
additional 2,085,000


                                       37
<PAGE>

ordinary shares. The proceeds from these offerings together with cash flow from
operations and our credit facilities are our main sources of working capital.

      We expect to fund our short-term liquidity needs, including our
obligations under our credit facilities, other contractual agreements and any
other working capital requirements, from cash and cash equivalents, operating
cash flow and our credit facilities. We believe that our current cash and cash
equivalents, including deposits, and our expected cash flow from operations in
2003 will be sufficient to meet our planned and potential cash requirements in
2003.

      We expect to fund our long-term liquidity needs, including contractual
obligations and anticipated capital expenditures, from our cash and cash
equivalents, operating cash flow and our credit facilities.

      During 2002, we experienced $1.6 million in losses attributable to the
start-up of operations of Smart Interactive Systems. We expect that Smart
Interactive Systems will operate on a breakeven basis by the end of 2003.

      Our working capital at December 31, 2002 was $15.8 million compared to
$18.4 million at December 31, 2001. Cash and cash equivalents (including short
and long-term bank deposits) amounted to $14.9 million at December 31, 2002,
compared to $14.6 million at December 31, 2001. Our cash and cash equivalents
are held mainly in dollars.

      We used net cash from operations of $2.6 million for the year ended
December 31, 2002, compared to $368,000 for the year ended December 31, 2001 and
net cash generated from operations of $4.6 million for the year ended December
31, 2000. The decrease in cash from operations was primarily due to operating
expenses associated with Smart Interactive Systems, an increase in unbilled
accounts receivable and an increase in other accounts receivable.

      Purchases of property and equipment in 2000, 2001 and 2002 were $3.8
million, $1.2 million and $1.5 million, respectively. Capital expenditures in
2002 were principally for equipment for Smart Interactive Systems, computers and
other machinery and equipment. Capital expenditures in 2001 were principally for
the acquisition of equipment for Smart Interactive Systems. Capital expenditures
in 2000 were principally for PPI's acquisition of its new facility in Fremont.
As of the date of this annual report, we estimate that our capital expenditures
for 2003 will be approximately $2.4 million, of which 19% will occur in Israel,
65% in the U.S. and 16% in other countries. As of May 31, 2003, we have spent
approximately 25% of this amount. We expect to finance these expenditures
primarily from our cash and cash equivalents, operating cash flow and our credit
facilities. However, the actual amount of our capital expenditures for 2003 will
depend on a variety of factors, including general economic conditions, changes
in the demand for our products and the risks and uncertainties involved in doing
business in Israel. See Item 3.D. "Key Information-Risk Factors."

      We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain sales and
purchase transactions. During 2002 we did not enter into any such contracts and
as of December 31, 2002, we had no derivative financial instruments.

Credit Lines and Other Debt and Related Party Transactions

      We currently have credit lines with Bank Leumi Israel, Union Bank of
Israel and Bank Hapoalim Israel totaling $16.0 million in the aggregate. There
are no restrictions as to our use of each of these credit lines. In connection
with two of these credit lines, a fixed charge was placed on our physical plant
in Israel by each of Bank Leumi Israel and Union Bank of Israel, each of


                                       38
<PAGE>

which ranks pari-passu with the other. In addition, we agreed not to pledge any
of our assets without the consent of these banks.

      We have undertaken to maintain the following financial ratios and terms in
respect of our credit lines with each of Bank Leumi Israel and Union Bank of
Israel:

o     A ratio of at least 40% of shareholders' equity out of the total balance
      sheet;

o     Minimal annual net income in the amount of $1 million; and

o     That the same shareholders maintain the core control in our company.

      As of December 31, 2002, we were in compliance with these ratios and
terms. These two banks will be entitled to demand the immediate repayment of any
of our outstanding indebtedness to them and may terminate our credit lines with
them if we fail to fulfill our undertakings. Our borrowings under these credit
lines are generally denominated in dollars. However, we may occasionally have
short-term NIS-denominated borrowings.

      In addition, our subsidiaries currently have credit lines with Bank Leumi
USA, Royal Bank of Canada and Deutsche Bank totaling $8.0 million in the
aggregate.

      As of December 31, 2002, we had approximately $2.8 million available under
our credit lines. In addition, our subsidiaries have approximately $1.2 million
available under their credit lines.

      As of December 31, 2002, we had outstanding under our credit lines:

o     short-term NIS-denominated borrowings of approximately $3.3 million,
      bearing interest at a rate of 9.9%-10.4%;

o     short-term dollar-denominated borrowings of approximately $5.1 million,
      bearing interest at a rate of 2.28%-3.25%. Interest on the outstanding
      balance is due each quarter;

o     several bank performance and advance payment guarantees totaling
      approximately $4.6 million, at an annual cost of 0.5%-1.0%; and

o     an approximately $262,000 guarantee in connection with one of our
      subsidiaries' credit lines, at an annual cost of 0.55%.

      As of December 31, 2002, Senstar had outstanding, in the aggregate,
short-term Canadian $ denominated borrowings of $843,000, bearing interest at a
rate of Canadian Prime plus 0.5% (5.0% at December 31, 2002). This loan is
collateralized by a general security agreement.

      As of December 31, 2002, our subsidiaries had outstanding, in the
aggregate, $5.8 million in long-term borrowings as follows:

      o     $2.5 million, bearing interest at an annual rate of 4.60%. The
            interest on the outstanding balance under this borrowing is due
            monthly. This borrowing matured in April 2002, but was extended to
            April 2004;

      o     $250,000, bearing interest at an annual rate of LIBOR plus 0.5%.
            This borrowing matured in April 2002, but was extended to April
            2004;


                                       39
<PAGE>

      o     $500,000, bearing interest at an annual rate of 5.662% and
            collateralized by PPI's assets. The interest on the outstanding
            balance under this borrowing is due quarterly, with the principal
            due in one installment in April 2003. This note was extended to
            April 2004;

      o     $500,000, bearing interest at an annual rate of 2.875% and
            collateralized by PPI's assets. This borrowing matured in April 2002
            and has been extended to April 2004; and

      o     $2.0 million mortgage loan to PPI bearing interest at a fixed rate
            of 8.25%. The mortgage is due in 18 quarterly installments of
            $64,700, commencing February 2001, with a final payment of
            approximately $1.8 million due in November 2005. In connection with
            this mortgage loan, PPI has granted the bank a first mortgage on its
            premises. In addition, we have guaranteed the full amount of this
            mortgage loan.

      In connection with our non-mortgage related borrowings listed immediately
above, Bank Leumi USA placed a $3.25 million fixed charge on our deposits with
that bank.

      As of December 31, 2002, Senstar GmbH obtained bank performance guarantees
in the amount of $ 44,000.

      As of December 31, 2002, Senstar issued a letter of credit in the amount
of $88,000 in connection with the purchase of supplies.

Contractual Cash Obligations

      Our significant contractual obligations as of December 31, 2002, and the
periods in which such obligations are due are as follows:

<TABLE>
<CAPTION>
                                                                         Payments Due by Period
                                                   ---------------------------------------------------------------
                                                                 Less than                                  After
         Contractual Obligations                    Total         1 Year       1-2 Years    3-4 Years      4 Years
-------------------------------------------        -------       ---------     ---------    ---------      -------
                                                                             (in thousands)
<S>                                                <C>            <C>            <C>           <C>         <C>
Short-term bank debt ......................        $ 9,266        $ 9,266        $   --        $ --        $   --
Long-term debt ............................          5,789          1,091         4,698          --            --
Capital lease obligations .................            321            117           174          30            --
                                                   -------        -------        ------        ----        ------
   Total contractual cash obligations .....        $15,376        $10,474        $4,872        $ 30        $   --
                                                   -------        -------        ------        ----        ------

<CAPTION>
                                                             Amount of Commitment Expiration Per Period
                                                   ---------------------------------------------------------------
                                                    Total
                                                   Amounts       Less than                                   Over
               Commitments                        Committed       1 Year       1-2 Years    3-4 Years      4 Years
-------------------------------------------        -------       ---------     ---------    ---------      -------
                                                                             (in thousands)
<S>                                                <C>            <C>            <C>           <C>         <C>
Lines of credit ...........................        $24,000        $24,000        $   --        $ --        $   --
Guarantees ................................          7,005          4,447         2,558          --            --
Other commitments(1) ......................          1,691            123           251         163         1,154
                                                   -------        -------        ------        ----        ------
   Total commercial commitments ...........        $32,696        $28,570        $2,809        $163        $1,154
                                                   -------        -------        ------        ----        ------
</TABLE>

                                       40
<PAGE>

----------
(1)   Inlcudes management's estimate of our royalty obligations to the OCS and
      the Fund for the Encouragement of Marketing of the Government of Israel.
      Pursuant to the terms of the grants we received from the OCS, we are
      obligated to pay royalties of 3% to 4% of revenues derived from sales of
      products funded with these grants. Pursuant to the terms of the grants we
      received from the Fund for the Encouragement of Marketing of the
      Government of Israel, we are obligated to pay royalties to this fund at
      the rate of 3% of the increase in export sales since 1991, up to the
      amount of the grants we received. Actual sales of our products for which
      we would be obligated to pay royalties to the OCS and the Fund for the
      Encouragement of Marketing of the Government of Israel may differ from
      management's estimates due to a variety of factors. See Item 3.D. "Key
      Information-Risk Factors."

C. Research and Development, Patents and Licenses

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

D. Trend Information

      At the end of 2002 we won a bid to protect the Otopeni International
Airport in Bucharest, Romania. The contract totals approximately $16 million and
is expected to be completed by the end of the year 2004. This turnkey project
includes different types of security systems that will be integrated by MagNet.

      We cannot assure you that the MOD, IDF or any of our other major customers
will maintain their volume of business with us or that, if such volume is
reduced, other customers of similar volume will replace the lost business. The
loss of one or more of these existing customers without replacement by a
customer or customers of similar volume would have a material adverse effect on
our financial results.

      For additional discussion of the information required by this item see
Item 5.A. "Operating and Financial Review and Prospects-Operating Results" and
Item 5.B. "Operating and Financial Review and Prospects-Liquidity and Financial
Resources".

ITEM 6. Directors, Senior Management and Employees

A. Directors and Senior Management

      Our directors and executive officers are as follows:

<TABLE>
<CAPTION>
Name                                        Age     Position
----                                        ---     --------
<S>                                         <C>     <C>
Jacob Even-Ezra.........................    72      Chairman of the Board and Chief Executive Officer
Izhar Dekel.............................    51      President and Director
Brig. Gen. (Ret.) Emanuel Shaked........    73      Vice President - Africa and Latin America  Marketing
Chaim Porat.............................    67      Vice President - Far East and Australia Marketing
Yehezkel Farber.........................    62      Vice President - Operations
</TABLE>


                                       41
<PAGE>

<TABLE>
<CAPTION>
Name                                        Age     Position
----                                        ---     --------
<S>                                         <C>     <C>
Tzvi Dank...............................    53      Vice President - Research and Development
Raya Asher..............................    35      Vice President - Finance, Chief Financial Officer,
                                                    Secretary and Director
Asaf Even-Ezra..........................    37      Vice President - Israel and West European Marketing
Dany Pizen..............................    51      Vice President - East European and CIS Marketing
Ofer Katz...............................    54      Vice President - Aviation Security
Nathan Kirsh............................    71      Director
Jacob Nuss..............................    55      Director
Jacob Perry ............................    59      Director
Shlomo Yanai............................    51      Director
Menachem Meron..........................    75      External Director
Itzhak Hoffi............................    76      External Director
</TABLE>

      Our articles of association provide for a board of directors of not less
than three and not more than eleven members; as may be determined from time to
time at our annual general meeting. All questions that arise at meetings of the
board of directors are decided by majority vote. In the event of a tie, the
chairman of the board casts the deciding vote. All directors, other than
external directors who serve for three years, hold office until the next annual
general meeting of shareholders and until their successors have been elected.
Officers serve at the discretion of the board of directors, subject to the terms
of any agreement between them and us and the provisions of the Israeli Companies
Law, 5739-1999, known as the Companies Law.

      Jacob Even-Ezra has served as our chairman of the board and chief
executive officer since 1984, and from 1987 until 1990 he also served as our
president. He is currently a member of the Executive Council and the Management
Committee of Tel-Aviv University. From 1985 to 1988, Mr. Even-Ezra was also
chairman of the Israel Export Institute. Mr. Even-Ezra is a beneficial owner of
15.5% of the total ordinary shares of our company held by Mira Mag Inc., a
holding company that is one of our principal shareholders.

      Izhar Dekel has served as our president since 1990. He became a director
in 1993. Mr. Dekel served as our finance manager from 1984 to 1990.

      Brigadier-General (Ret.) Emanuel Shaked has been our vice president-
Africa and Latin America marketing since 1986. Before joining us, Mr. Shaked
served as the head of the Operations Department of the IDF, head of special
operations, and commander-in-chief of the Paratroop Corps.

      Chaim Porat has been our vice president- Far East and Australian marketing
since 1988. Prior to joining us, Mr. Porat worked for Beta Engineering Ltd. as
the head of its security division.

      Yehezkel Farber has been our vice president- operations since 1986.
Previously Mr. Farber was the manager of the customer systems department of IAI.

      Tzvi Dank has been vice president- research and development with us and
our predecessor since 1984. Before joining us, Mr. Dank worked as an electronic
engineer in the electronics division of IAI.

      Raya Asher joined us in 1998 as vice president- finance, chief financial
officer and secretary. Ms. Asher was elected to serve as a director in 2001.
Prior to joining us, Ms. Asher served as a senior audit manager with Kost Forer
& Gabbay, Certified Public Accountants in Israel. Ms. Asher has a M.B.A. in
business and a B.A. in accounting and economics from Tel Aviv University and is
a member of the Israeli CPA Association.


                                       42
<PAGE>

      Asaf Even-Ezra joined us in 1995 and has been our vice president- Israel
and West European marketing since 1998. Mr. Even-Ezra also heads our video
motion detection division.

      Dany Pizen joined us in 1997 as vice president- East European and CIS
marketing. Before joining us, Mr. Pizen served as vice president of business
development of Eldor Electronics Ltd., before which he served for 20 years in
the IDF, where he was a Lt. Colonel.

      Ofer Katz joined us in 1984. Before becoming our vice president- aviation
security in 1995, he served in our software and computer development department
as manager of our production line and in operations and special projects.

      Nathan Kirsh has served as a director since 1984. Mr. Kirsh is an
independent investor. Mr. Kirsh serves as one of the trustees of the Eurona
Foundation, the beneficial owner of 84.5% of the total ordinary shares of our
company held by Mira Mag Inc., a holding company that is one of our principal
shareholders.

      Jacob Nuss has served as a director since 1993. Mr. Nuss has served as the
deputy vice president-internal auditing of IAI since 1999, and from 1993 to
1999, Mr. Nuss served as the director of finance of IAI's electronics group.
From 1991 to 1993, Mr. Nuss served as assistant to the chairman of the board of
IAI. Since 1975, Mr. Nuss has served in various financial management capacities
at IAI. IAI is a 11.88% shareholder in our company.

      Jacob Perry was appointed to serve as a director in December 2002. From
1995 to December 2002, Mr. Perry was President and CEO of Cellcom Israel Ltd.,
Israel's largest cellular phone operator. Mr. Perry served 29 years at the
Israeli General Security Service, and served as its Chief from 1988 until 1995.
Mr. Perry has also served as an adviser to the Israeli Prime Minister on the
subject of prisoners of war and missing persons. He was a board member of El-Al
Israel Airlines and a member of the executive staff of many public
organizations. Mr. Perry is also a Chairman of the Board of Directors of various
companies, including Mizrahi Bank B.M., Lipman Electronic Engineering Ltd. and
Aeronautics Defense Systems Ltd. Mr. Perry also acts as an advisor to Cellguide
Ltd.

      Shlomo Yanai was appointed to serve as a director in January 2003. Since
May 2003, Mr. Yanai has served as the CEO of Makhteshim Agan Industries Ltd., an
Israeli agro-chemicals company listed on the Tel Aviv Stock Exchange. Mr. Yanai
served 32 years with the Israeli Defense Forces ("IDF") until 2001. During his
long military career with the IDF, Mr. Yanai served as the commanding officer of
an armored division from 1992 to 1994, the Head of the Army R&D and Procurement
Division from 1994 to 1996, Commanding Officer of the IDF Southern Command from
1996 to 1998, as well as Head of the Division of Strategy Planning of the IDF
from 1998 to 2001. In addition to these positions, Mr. Yanai was the head of the
Israeli security delegation to the peace talks at Camp David, Shepherdstown and
Wye River. Mr. Yanai received a B.A. in Political Science and Economics from the
Tel Aviv University, and an M.P.A in National Resources Management from the
George Washington University. He is also a graduate of Harvard University's
Advanced Management Program, which he completed during his academic sabbatical
leave in 2001. During 2001 he was a research fellow at the Washington Institute.

      Menachem Meron has served as an External Director as of June 2001 and as a
director since 1993. Since 1988 Mr. Meron has been the general manager of IFTIC
Ltd., an international consulting company. Mr. Meron currently serves on the
boards of directors of the following companies, First International Bank,
Israel, PAZ Lubricants and Chemicals Co. Ltd., Polar Investments Ltd., and
Supercom Ltd. Mr. Meron, a retired Major General of the IDF, has previously
served as the director general of the Israeli Minstry of Defense.


                                       43
<PAGE>

      Itzhak Hoffi has served as an External Director as of June 2001 and as a
director since December 1996. Mr. Hoffi is also a member of the boards of
directors of various companies, including: Orad Hi Tec Systems Ltd., Palram
Industries (1990) Ltd. and Bank Leumi Le Israel Ltd. From 1994 until 2000, and
since May 2002, Mr. Hoffi has served as chairman of the board of Tadiran Ltd.
From 1982 to 1990, Mr. Hoffi served as general manager of the Israel Electric
Corporation Ltd. From 1974 until 1982, Mr. Hoffi was the head of the Mossad,
Israeli's secret intelligence service.

      Jacob Even Ezra and Asaf Even Ezra are father and son. Izhar Dekel is
Jacob Even Ezra's son in law and Asaf Even Ezra's brother in law. Other than the
relationships between Jacob Even-Ezra, Asaf Even-Ezra and Izhar Dekel, there are
no other family relationships among our directors and senior executives.

      Mira Mag and IAI have entered into an agreement regarding, among other
things, the election of directors. Pursuant to this agreement, IAI has the right
to nominate one director for every three directors nominated by Mira Mag. In
connection with this agreement, Mira Mag has nominated Jacob Even-Ezra and
Nathan Kirsh to our board of directors and IAI has nominated Jacob Nuss to our
board of directors.

B. Compensation

      During the fiscal year ended December 31, 2002, we paid aggregate
compensation to all of our officers and directors as a group (consisting of 14
persons) of approximately $1.5 million. In addition, we have provided
automobiles to our executive officers at our expense. We have two key-man life
insurance policies for Izhar Dekel. We are the beneficiary of one of these
policies and certain of Mr. Dekel's family members are the beneficiaries of the
other policy. We bear the cost of each of these insurance policies. We also have
a key-man life insurance policy for Jacob Even-Ezra, for which we are the
beneficiary.

      Directors who are not officers of us or of any entity that beneficially
owns 5% or more of our ordinary shares receive an annual fee of approximately
$5,400 and an additional fee of approximately $300 for each board or committee
meeting that they attend.

      Under the Companies Law, the board of directors must approve all
compensation arrangements of office holders who are not directors. Directors'
compensation arrangements (other than external directors) also require audit
committee approval before board approval and shareholder approval. However,
pursuant to recent amendments to the Companies Regulations (Relief from Related
Party Transactions), 5760-2000, directors' compensation and employment
arrangements do not require, in certain circumstances, shareholder approval.
Such approval is not required if both the audit committee and the board of
directors agree that such arrangements are solely for the benefit of the
company. In addition, if the director or office holder is a controlling
shareholder of the company, then the employment and compensation arrangements of
such director or office holder do not require shareholder approval if such
arrangements meet certain criteria.

      An external director is entitled to compensation as provided in
regulations promulgated under the Companies Law and is otherwise precluded from
receiving any other compensation, directly or indirectly, in connection with
such service.

      During 2002, we did not grant any options to purchase ordinary shares to
our directors and executive officers. We have no service contracts with any of
our directors to provide services as a director that provide for benefits upon
termination of employment. However, we do have employment agreements with
certain of our directors in connection with their service as


                                       44
<PAGE>

employees. During the fiscal year ended December 31, 2002, we set aside an
aggregate of approximately $154,000 for our directors and executive officers as
a group (14 persons) to provide pension, retirement or similar benefits for
them.

C. Board Practices

      We are subject to the provisions of the Companies Law, which became
effective on February 1, 2000, superseding most of the provisions of the Israeli
Companies Ordinance (New Version), 5743-1983. The Companies Law authorizes the
Minister of Justice to adopt regulations exempting from the provisions described
below companies, such as us, whose shares are traded both in Israel and outside
of Israel.

Appointment of Directors and Term of Office

      Our directors, other than our external directors as described below, are
appointed by our shareholders at our annual general meeting and hold office
until the next annual general meeting. Our annual general meetings are held at
least once every calendar year, but not more than fifteen months after the last
preceding annual general meeting. In the intervals between our annual general
meetings, the board of directors may appoint new directors to fill vacancies.
Our officers serve at the discretion of the board of directors, subject to the
terms of any agreement between them and us and the provisions of the Companies
Law.

Directors' Service Contracts

      See Item 6.B. "Directors, Senior Management and Employees-Compensation"
above.

Alternate Directors

      Our articles of association provide that any director may, by written
notice to us, appoint another person to serve as an alternate director, subject
to the approval of the board of directors. Under the Companies Law, any person
who is not a director or an alternate director may act as an alternate director,
but the same person may not act as an alternate for several directors. An
alternate director may be appointed for one meeting or for another specified
period or until notice is given of the cancellation of the appointment. To our
knowledge, no director currently intends to appoint any other person as an
alternate director, except if the director is unable to attend a meeting of the
board of directors.

External Directors

      Under the Companies Law, companies incorporated under the laws of Israel
whose shares have been offered to the public in Israel or outside of Israel are
required to appoint two external directors. The Companies Law requires that the
external directors be residents of Israel. However, the Minister of Justice of
the State of Israel has promulgated regulations exempting certain qualifying
dual listed companies, such as us, from the applicability of certain provisions
of the Companies Law. The Companies Regulations (Concessions for Public
Companies Whose Shares are Registered in a Stock Exchange outside Israel),
5760-2000, as amended, define "double foreign company" as a public company whose
shares

o     have been offered to the public outside of Israel or were registered on a
      non-Israeli stock exchange prior to February 1, 2000; and

o     were registered on a stock exchange in Israel after such date.


                                       45
<PAGE>

Pursuant to these regulations, an external director of a double foreign company
need not be an Israeli resident.

      The Companies Law provides that a person may not be appointed as an
external director if the person or the person's relative, partner, employer or
any entity under the person's control, has, as of the date of the person's
appointment to serve as an external director, or had, during the two years
preceding that date, any affiliation with the company, any entity controlling
the company or any entity controlled by the company or by this controlling
entity. The term affiliation includes:

o     an employment relationship;

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

o     control; and

o     service as an officer holder.

The Companies Law further provides that if at the time the external directors
are appointed a company's board of directors is comprised solely of members of
the same gender, then at least one of the external directors must be of a
different gender than the other directors.

      No person may serve as an external director if the person's position or
other business creates, or may create, conflicts of interest with such 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.

      External directors are elected by a majority vote at a shareholders'
meeting, provided that either:

o     the majority of shares voted at the meeting including at least one third
      of the shares of non-controlling shareholders voted at the meeting, vote
      in favor of the election; or

o     the total number of shares voted against the election of the external
      director does not exceed one percent of the aggregate voting rights in the
      company.

      The initial term of an external director is three years and may be
extended for an additional three years. Each of the external directors is
required to serve on the company's audit committee. Each other committee of a
company's board of directors is required to include at least one external
director. An external director is entitled to compensation as provided in
regulations under the Companies Law and is prohibited from receiving any other
compensation, directly or indirectly, in connection with such service.

      Under the Nasdaq rules, we are required to have at least two independent
directors on our board of directors. In addition, the majority of the members of
our audit committee must be independent. Mr. Meron and Mr. Hoffi qualify as
independent directors under the Nasdaq rules and as external directors under the
Companies Law. Under the Sarbanes-Oxley Act of 2002, we will be required in the
future to have three independent directors on our audit committee.


                                       46
<PAGE>

Audit Committee

      Under the Companies Law, the board of directors of any company that is
required to nominate external directors must also appoint an audit committee
comprised of at least three directors, including all of the external directors,
but excluding the chairman of the board of directors, the general manager, the
chief executive officer, a controlling shareholder or a relative of a
controlling shareholder and any director employed by the company or who provides
services to the company on a regular basis. Menachem Meron, Itzhak Hoffi and
Jacob Nuss serve as the members of our audit committee. The role of the audit
committee is to examine flaws in our business management in consultation with
our internal auditor and our independent accountants, and to suggest appropriate
courses of action.

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

      The Audit Committee assists the Board of Directors in monitoring: (i) the
integrity of the financial statements of the company; (ii) the compliance by the
company with legal and regulatory requirements; and (iii) the independence and
performance of our external auditors. Management is responsible for the
preparation and integrity of our financial statements.

      The Audit Committee reviewed our audited financial statements for the year
ended December 31, 2002 and members of the Committee met with both management
and our external auditors to discuss those financial statements. Management and
the external auditors have represented to the Audit Committee that the financial
statements were prepared in accordance with the generally accepted accounting
principles in the U.S. Members of the Audit Committee have discussed with the
external auditors their written disclosure and received a letter regarding their
independence from our company as required by Independence Standards Board
Standard No. 1. Members of the Audit Committee also discussed with the external
auditors any matters required to be discussed by Statement on Auditing Standards
No. 61. Based upon these reviews and discussions, the Audit Committee has
recommended to the Board of Directors that the audited financial statements be
included in our Annual Report on Form 20-F for the year ended December 31, 2002.

Internal Auditor

      Under the Companies Law, the board of directors must appoint an internal
auditor proposed by the audit committee. The role of the internal auditor is to
examine whether the company's actions comply with the law, integrity and orderly
business procedure. Under the Companies Law, the internal auditor may not be an
interested party, an office holder, or an affiliate, or a relative of an
interested party, office holder or affiliate, nor may the internal auditor be
the company's independent accountant or its representative. Daniel Spira, CPA
(Isr.) is our internal auditor.

Approval of Specific Related-Party Transactions

      The 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


                                       47
<PAGE>

to act with the level of care that a reasonable office holder in the same
position would have acted under the same circumstances. An office holder's duty
of care includes a duty to use reasonable means to obtain:

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

o     all other important information pertaining to these actions.

      An office holder's duty of loyalty includes a duty to:

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

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

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

o     disclose to the company any information or documents relating to the
      company's affairs which the office holder has received due to his position
      as an office holder.

      The 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. If the transaction is an extraordinary transaction, the office
holder must also disclose any personal interest held by:

o     the office holder's spouse, siblings, parents, grandparents, descendents,
      spouse's descendents and the spouses of any of these people; or

o     any corporation in which the office holder is a 5% or greater shareholder,
      director or general manager or in which he has the right to appoint at
      least one director or the general manager.

      Under Israeli law, an extraordinary transaction is a transaction:

o     other than in the ordinary course of business;

o     other than on market terms; or

o     that is likely to have a material impact on a company's profitability,
      assets or liabilities.

      Under the 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 may not 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, shareholder approval may also be required. An office
holder who has a personal interest in a matter that is being


                                       48
<PAGE>

considered at a meeting of the board of directors or the audit committee may not
be present at such meeting or vote on such matter.

      Under the Companies Law, the disclosure requirements that apply to an
office holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder that holds 25% or more of the
voting rights in a public company, provided 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, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the board of
directors and the shareholders of the company. The shareholder approval may
include either at least one-third of the shareholders who have no personal
interest in the transaction and are present and voting, in person, by proxy or
by written ballot, at the meeting, or a majority of the voting power present and
voting, provided that the shareholders who have no personal interest in the
transaction who vote against the transaction do not represent more than one
percent of the voting rights in the company. For a discussion of certain
Companies Law regulations pertaining to tender offers by shareholders, see Item
10.B. "Additional Information-Memorandum and Articles of Association-Provisions
Restricting a Change in Control of Our Company."

      The Companies Law requires that every shareholder that participates,
either in person or by proxy, in a vote regarding a transaction with a
controlling member of the company 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. Regulations promulgated under the
Companies Law provide that this requirement does not apply to a company whose
shares are publicly traded outside of Israel if, pursuant to applicable foreign
securities laws, the company is required to distribute a proxy statement.

      However, under the Companies Regulations (Relief From Related Party
Transactions), 5760-2000, promulgated pursuant to the Companies Law, each of the
following transactions between a company and its controlling shareholder(s) does
not require shareholder approval:

o     the extension of the term of an existing related-party transaction;
      provided that the original transaction was duly approved in accordance
      with the applicable provisions of the Companies Law or the Israeli
      Securities Law and regulations promulgated thereunder;

o     a transaction that has been approved by the audit committee and the board
      of directors as being solely for the benefit of the company;

o     a transaction between the company and its controlling shareholder(s) or an
      entity in which the controlling shareholder has a personal interest,
      provided that the audit committee and the board of directors approve the
      transaction and determine that the transaction is in accordance with the
      terms defined in a duly approved frame-work transaction. A frame-work
      transaction is a transaction that defines the general terms under which
      the company may, in the ordinary course of business, enter into
      transactions of a similar type;

o     a transaction between the company and its controlling shareholder(s) or an
      entity in which the controlling shareholder has a personal interest, for
      the purpose of entering into a transaction with a third party or to submit
      a joint offer to conduct business with a third party, provided that the
      audit committee and the board of directors have approved the transaction
      and that the terms of the transaction in relation to the company are not
      materially different from those relating to the


                                       49
<PAGE>

      controlling shareholder(s) or an entity in which the controlling
      shareholder has a personal interest, taking into account their
      proportionate participation in the transaction; and

o     a transaction between companies that are controlled by the same
      controlling shareholder or between the company and an entity in which the
      controlling shareholder has a personal interest, provided that for each
      public company involved, the audit committee and the board of directors
      find that the transaction is in accordance with market terms, is in the
      ordinary course of business and does not harm the welfare of the company.

      In addition, pursuant to the recent amendment to these regulations,
directors' compensation and employment arrangements do not require shareholder
approval if both the audit committee and the board of directors agree that such
arrangements are solely for the benefit of the company. Also, if the director or
the office holder is a controlling shareholder of the company, then the
employment and compensation arrangements of such director or office holder do
not require shareholder approval, provided certain criteria are met.

      The relief from having to obtain shareholder approval set forth above will
not apply, and shareholder approval will be required, if one or more
shareholders, holding at least 1% of the issued and outstanding share capital of
the company or of the company's voting rights, object to the grant of such
relief, provided that such objection is submitted to the company in writing not
later than seven days from the date of the filing of a report regarding the
adoption of such resolution by the company pursuant to the requirements of the
Israeli Securities Law (which reporting requirements are not applicable to us as
a "double foreign company").

      Further, since our ordinary shares are listed on the Tel Aviv Stock
Exchange, we are subject to additional provisions of the Companies Law. These
provisions require that the board of directors and shareholders approve any
private placement of securities by a public company that will:

o     increase the relative holdings of a shareholder that holds 5% or more of
      that company's outstanding share capital; or

o     cause any person to become, as a result of such issuance, a holder of more
      than 5% of such company's outstanding share capital.

However, in accordance with the Companies Regulations (Relief From Related Party
Transactions), 5760-2000, shareholder approval is not required for a private
placement in which less than 20% of the voting rights in the company, prior to
such offer, are offered. For purposes of such exemption, the definition of a
private placement includes:

o     private placements that are part of the same transaction or that are
      contingent or conditioned upon a previous private placement; and

o     all private placements effected by the issuer in the previous twelve-month
      period in which the same parties, or relatives or affiliates thereof, were
      involved, or the consideration thereof consists of rights to the same
      assets.

These private placement exemptions do not apply to private placements made to a
director or chief executive officer of the issuer or to a person or entity that
will become, as a result of such private placement, a controlling shareholder of
the issuer.


                                       50
<PAGE>

      The 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 the 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 and can be
personally liable for a breach of such duty.

Indemnification of Directors and Officers and Limitations of Liability

      The Companies Law provides that a company may not exonerate office holders
from liability for a breach of their duty of loyalty, but may exonerate in
advance office holders from their liability to the company, in whole or in part,
for a breach of their duty of care. Our articles of association provide that,
subject to any restrictions imposed by the Companies Law, we may enter into an
insurance contract providing coverage for the liability of any of our office
holders for:

o     a breach of their duty of care to us or to another person;

o     a breach of their duty of loyalty to us, provided that they acted in good
      faith and had reasonable grounds to assume that their act would not
      prejudice our interests; and

o     a financial liability imposed upon them in favor of another person for an
      act performed by them in their capacity as office holders.

      In addition, we may indemnify office holders against the following
expenses or liabilities imposed upon them in their capacity as office holders:

o     a financial liability imposed on them in favor of another person by any
      judgment, including a settlement or an arbitrator's award approved by a
      court; and

o     reasonable litigation expenses, including attorneys' fees, incurred by
      such office holders or imposed upon them by a court, in connection with
      proceedings instigated by us against them or that are instigated on our
      behalf or by another person, or as a result of a criminal charge from
      which they were acquitted or a criminal charge in which they were
      convicted for a criminal offense that does not require proof of intent.

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

o     a breach by an officer holder of their 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;

o     a breach by an office holder of their duty of care if such breach was
      committed intentionally or recklessly;

o     an act or omission with the intent to unlawfully derive a personal
      benefit; or

o     a fine levied against the office holder as a result of a criminal offense.


                                       51
<PAGE>

      Under the Companies Law, the shareholders of a company may include in, or
amend a company's articles of association to include, either of the following:

o     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 that 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

o     a provision authorizing the company to retroactively indemnify an office
      holder.

      In addition, pursuant to the Companies Law, indemnification of, and
procurement of insurance coverage for, a company's office holders must be
approved by the audit committee and the board of directors. In the case of
directors, shareholder approval is also required.

      We currently maintain a directors and officers liability insurance policy
with a per claim and aggregate coverage limit of $5 million.

D. Employees

      As of December 31, 2002, we employed 266 full-time employees, of whom 26
were employed in general management and administration, 46 in marketing, 37 in
production management, 111 in production, installation and maintenance, and 46
in engineering and research and development. Of our 266 full-time employees, 120
are employed in Israel, 44 are employed in the U.S., 80 are employed in Canada
and 22 are employed in various other countries.

      We are subject to various Israeli labor laws, collective bargaining
agreements entered into from time to time between the Manufacturers Association
and the Histadrut, as well as collective bargaining arrangements. These laws,
agreements and arrangements cover a wide range of areas, including minimum
employment standards, such as working hours, minimum wages, vacation, severance
pay and pension plans, and special issues, such as equal pay for equal work,
equal opportunity in employment and employment of youth and army veterans.
Certain of our employees are parties to individual employment agreements. We
generally provide our employees with benefits and working conditions beyond the
required minimums. Each of our subsidiaries provides a benefits package and
working conditions which are competitive with other firms in their area of
operations.

      Israeli law generally requires severance pay upon the retirement or death
of an employee or termination of employment without due cause. Furthermore,
Israeli employees and employers are required to pay predetermined sums to the
National Insurance Institute, which is similar to the U.S. Social Security
Administration, which amounts also include payments for national health
insurance.

E. Share Ownership

      The following table sets forth certain information regarding the ownership
of our ordinary shares by our directors and executive officers as of June 17,
2003. The percentage of outstanding ordinary shares is based on 7,696,517
ordinary shares outstanding as of June 17, 2003.


                                       52
<PAGE>

                                                                Percentage of
                                      Number of Ordinary    Outstanding Ordinary
                  Name                  Shares Owned(1)             Shares
      -----------------------------   ------------------    --------------------
      Jacob Even-Ezra(2)(6)(7) ....         668,692                 8.69%
      Izhar Dekel(3)(7) ...........              --                   --
      Brig. Gen. (Ret.)
         Emanuel Shaked ...........              --                   --
      Chaim Porat .................              --                   --
      Yehezkel Farber .............              --                   --
      Tzvi Dank ...................              --                   --
      Raya Asher ..................              --                   --
      Asaf Even-Ezra(4)(6) ........         331,249                 4.30%
      Dany Pizen ..................              --                   --
      Ofer Katz ...................              --                   --
      Nathan Kirsh(5) .............       2,759,417                35.85%
      Jacob Nuss ..................              --                   --
      Jacob Perry .................              --                   --
      Shlomo Yanai ................              --                   --
      Menachem Meron ..............              --                   --
      Itzhak Hoffi ................              --                   --

----------
*     Less than 1%.

(1)   Except as otherwise noted and pursuant to applicable community property
      laws, each person named in the table has sole voting and investment power
      with respect to all ordinary shares listed as owned by such person. Does
      not include shares that may be acquired pursuant to the exercise of
      options.

(2)   Includes Mr. Even-Ezra's beneficial ownership of 506,165 ordinary shares
      held by Mira Mag and Mr. Even-Ezra's beneficial ownership of an additional
      162,527 ordinary shares owned jointly by his three children, Ornit Dekel,
      Guy and Asaf Even-Ezra over which Mr. Even-Ezra has voting and dispositive
      power.

(3)   Does not include any of the 506,165 ordinary shares held by Mira Mag in
      which Mr. Dekel's wife, Ornit Dekel, has an interest. Does not include any
      of the 162,527 ordinary shares owned jointly by Jacob Even-Ezra's three
      children, Ornit Dekel and Guy and Asaf Even-Ezra.

(4)   Includes one-third, or 168,722 of the 506,165 ordinary shares held by Mira
      Mag in which Mr. Even-Ezra has an interest. Includes all of the 162,527
      ordinary shares that Mr. Even-Ezra owns jointly with his brother Guy Even
      Ezra and his sister Ornit Dekel. Asaf Even-Ezra is the son of Jacob
      Even-Ezra.

(5)   The number of ordinary shares beneficially owned by Mr. Kirsh represents
      Mr. Kirsh's beneficial ownership of 2,759,417 ordinary shares held by Mira
      Mag. Mr. Kirsh is a trustee of the Eurona Foundation, which owns an 84.5%
      interest in Mira Mag.

(6)   Jacob Even-Ezra and Asaf Even-Ezra are father and son.

(7)   Izhar Dekel is Jacob Even Ezra's son- in-law and Asaf Even Ezra's
      brother-in-law.

      As of June 17, 2003, the directors and executive officers listed above, as
a group, held options to purchase 168,920 of our ordinary shares at a weighted
average exercise price of $3.47 per share, expiring between December 2003 and
June 2006.

Stock Option Plan

      On February 25, 1993, our board of directors adopted a stock option plan
pursuant to which stock options may be granted to employees, officers, directors
and consultants of us or any of our subsidiaries. The purpose and intent of our
stock option plan is to enhance our ability to attract and retain experienced
and competent employees, officers, directors and consultants by providing them
with opportunities to purchase our ordinary shares.


                                       53
<PAGE>

      Our stock option plan is administered by our board of directors, which has
the authority pursuant to the Companies Law to determine the persons to whom
options are granted, the number of ordinary shares to be covered by each option,
the time or times at which options are granted or exercised, and the terms and
provisions of the options. No option may be exercised before the second
anniversary of the date on which it was granted, and each option expires on or
before the fifth anniversary of the date on which it was granted. Pursuant to
the plan, any options that are cancelled or not exercised within the option
period will become available for future grants. The board of directors may
terminate or amend the plan in any respect, except that without prior
shareholder approval the total number of shares which may be issued under the
plan may not be increased, except by adjustment upon a recapitalization or
distribution of a stock dividend.

      In May 2000, our shareholders approved an amendment to our stock option
plan to increase the number of ordinary shares reserved for issuance upon the
exercise of options under the plan to 757,200 and to extend the term of the plan
for an additional four years until February 2005. In July 2002, our shareholders
approved an amendment to our plan to increase the number of ordinary shares
reserved for issuance upon the exercise of options under the plan by an
additional 500,000 ordinary shares. In addition, in July 2002 our shareholders
approved the payment of a 3% stock dividend to our shareholders. Pursuant to the
provisions of our stock option plan, if we issue a stock dividend, the number of
shares purchasable by any grantee upon the exercise of options that were granted
prior to the issuance of the stock dividend will be correspondingly increased.
Accordingly, a total of 1,269,212 ordinary shares are reserved for issuance upon
the exercise of options under the plan.

      In July 2002, our shareholders approved an amendment to the plan according
to which stock options granted under the plan are exercisable at a price per
share that is at least 75% of the average market price per share during the
90-day period preceding the grant of the options. Prior to this amendment, stock
options granted under the plan were exercisable at a price per share that was
75% of the average market price per share during the 90-day period preceding the
grant of the options.

      As of December 31, 2002 options to 358,234 shares were outstanding and
additional 585,902 were available for grant.

      Grants of stock options under the plan are accounted for by us over the
exercise periods thereof as a compensation expense with a corresponding credit
to our contributed capital. Ordinary shares subject to options under the plan
are to be valued for this purpose at their market value at the time the options
are granted.

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 17, 2003, by each person
or entity known to own beneficially more than 5% of our outstanding ordinary
shares based on the information provided to us by the holders or disclosed in
public filings with the Securities and Exchange Commission. The voting rights of
the shareholders listed below are not different from the voting rights of our
other shareholders.


                                       54
<PAGE>

                                                Number of       Percentage of
                                             Ordinary Shares      Outstanding
                                              Beneficially         Ordinary
      Name                                       Owned(1)          Shares(2)
      -------------------------------------  ---------------    -------------
      Mira Mag Inc.(3) ....................     3,265,582           42.43%
      Israel Aircraft Industries Ltd. .....       914,516           11.88%
      Jacob Even-Ezra(4) ..................       740,792            9.54%

----------
(1)   Ordinary shares beneficially owned include shares that may be acquired
      pursuant to options that are exercisable within 60 days of June 17, 2003.

(2)   The percentage of outstanding ordinary shares is based on 7,696,517
      ordinary shares outstanding as of June 17, 2003. Ordinary shares deemed
      beneficially owned by virtue of the right of any person to acquire such
      shares within 60 days of June 17, 2003, are treated as outstanding only
      for the purposes of determining the percent owned by such person.

(3)   Mira Mag is the holder of 3,265,582 ordinary shares. The beneficial owners
      and their percentage interest in these shares are: The Eurona Foundation
      84.5%, or 2,759,417 ordinary shares, and Jacob Even-Ezra's three children,
      15.5%, or 506,165 ordinary shares. Jacob Even-Ezra beneficially owns all
      of the 506,165 shares held by Mira Mag in which his children, Ornit Dekel
      and Guy and Asaf-Even Ezra, have an interest. The purpose of the Eurona
      Foundation, the trustees of which are Prinz Michael von Liechtenstein,
      Altenbach 8, P.O. Box 339, FL-9490 Vaduz, Liechtenstein, and Nathan Kirsh,
      Kapola Estate, Ezulwini, Swaziland, is to provide for the education,
      maintenance and support of the family of Nathan Kirsh and such other
      persons as the foundation's board may determine.

(4)   Includes Mr. Even-Ezra's beneficial ownership of 506,165 ordinary shares
      held by Mira Mag (see footnote (3) above) and Mr. Even-Ezra's beneficial
      ownership of an additional 234,627 ordinary shares owned jointly by his
      three children, Ornit Dekel and Guy and Asaf Even-Ezra, over which he has
      voting and dispositive power.

      As of June 16, 2003, there were 72 holders of ordinary shares of record
registered with a U.S. mailing address, including banks, brokers and nominees.
These holders of record represented approximately 49.5% of our total outstanding
ordinary shares. Because these holders of record include banks, brokers and
nominees, the beneficial owners of these ordinary shares may include persons who
reside outside the U.S.

B. Related Party Transactions.

Registration Rights Agreement

      In furtherance of the approval obtained at the extraordinary general
meeting of our shareholders held on November 20, 1995, we entered into a
registration rights agreement, dated as of November 18, 1996, with Mira Mag, IAI
and Jacob Even-Ezra. Pursuant to the registration rights agreement, upon the
request of any of these principal shareholders, we are required to prepare and
file, at our expense, with the Securities and Exchange Commission, a shelf
registration statement for the ordinary shares held by them. In addition, we
will indemnify them and any underwriter of such ordinary shares against certain
civil liabilities under the Securities Act in connection with an offering of
such ordinary shares. Pursuant to the registration rights agreement, in July
1998 we filed a registration statement on Form F-3, File No. 333-9050, for the
ordinary shares held by Mira Mag.


                                       55
<PAGE>

Agreement to Purchase Deferred Shares

      Pursuant to the Israeli Securities Law, a company may not register its
shares on any Israeli stock exchange unless its share capital consists of only
one class of shares. Further, pursuant to the Israeli Securities Law, an Israeli
company whose shares are traded on a stock exchange outside of Israel or on
Nasdaq, may register its shares on an Israeli stock exchange under a simplified
and expedited process. In connection with effectuating the dual registration of
our ordinary shares on Nasdaq and the Tel Aviv Stock Exchange, we were required
by the Israeli Securities Law to cancel all of our issued and outstanding
deferred shares. Accordingly, following approval by our audit committee, our
board of directors, and our shareholders at our 2001 annual general meeting, we
entered into an agreement pursuant to which we purchased 186,480 deferred shares
from Mira Mag and 65,520 deferred shares from IAI for aggregate consideration
equal to the aggregate nominal value of such deferred shares. We subsequently
cancelled the deferred shares that we purchased from Mira Mag and IAI.

Guarantees

      As of December 31, 2002, we guaranteed an approximately $262,000 line of
credit granted by Deutsche Bank to Senstar GmbH. During 2002, the largest amount
outstanding under this line of credit was approximately $450,000. As of May 31,
2003, there was no outstanding balance under this line of credit. The interest
rate on this line of credit is 3.3%-10.25%

      We guaranteed to Bank Leumi Israel an unlimited amount of Senstar's
$576,000 mortgage loan. During 2002, the largest amount outstanding under this
mortgage loan was approximately $75,000. As of December 31, 2002 the mortgage
loan was paid off in full and our guarantee expired. The interest rate on this
mortgage loan was LIBOR plus 0.75%.

      We guaranteed approximately $2.2 million of a mortgage loan from Bank
Leumi to PPI. During 2002, the largest amount outstanding under this mortgage
loan was $2.1 million. As of May 31, 2003, the amount outstanding under this
mortgage loan was approximately $2.0 million. The interest rate on this mortgage
loan is 8.25%.

      As of December 31, 2002, we and our subsidiaries obtained bank performance
guarantees and advance payment guarantees from several banks mainly in Israel in
the amount of $4.6 million.

      As of December 31, 2002, we and our subsidiaries issued letters of credit
in the amount of $88,000 in connection with the purchase of supplies.

Arrangements with Certain Subsidiaries

      We have arrangements with certain of our subsidiaries pursuant to which
these subsidiaries participate in certain of our expenses, primarily our
research and development, sales and marketing and general and administrative
expenses, on a cost basis. During 2002, the aggregate amount we received from
these subsidiaries in connection with such arrangements was approximately
$765,000.


                                       56
<PAGE>

Sales to Principal Shareholder

      We sell our perimeter systems to one of our principal shareholders, IAI,
which beneficially owns 914,516, or 11.88%, of our ordinary shares. Jacob Nuss,
one of our directors, is currently the deputy vice-president-internal auditing
of IAI and, since 1975, has served in various financial management capacities at
IAI. The terms of the contracts under which we make sales to IAI were negotiated
on an arms'-length basis and the terms of such contracts are no more favorable
to IAI than those it could have obtained from an unaffiliated third party. Our
sales to IAI during the years ended December 31, 2000, 2001 and 2002 were
$211,000, $261,000 and $111,000 respectivly.

Employment Contracts

      Jacob Even-Ezra and Izhar Dekel entered into substantially similar
employment agreements with us, effective January 1993. These agreements contain
certain non-competition and confidentiality provisions. In addition, each
agreement establishes a base salary and a package of benefits with an aggregate
value of approximately 20% of the base salary, as well as a possible bonus. In
April 2000, we extended the term of Mr. Even-Ezra's employment agreement until
January 2004. In December 2000, our board of directors amended the term of Mr.
Dekel's employment agreement. Under the amended agreement, the term of Mr.
Dekel's employment shall continue until such time as it is terminated by us or
by Mr. Dekel pursuant to the terms of the agreement.

      See also Item 6.B. "Directors, Senior Management and
Employees-Compensation" above.

C. Interests of Experts and Counsel.

      Not applicable.

ITEM 8. Financial Information

A. Consolidated Statements and Other Financial Information.

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

      In 2002, the total amount of our sales from our facilities located outside
of Israel to customers outside of Israel was approximately $31.6 million, or 74%
of our total sales. The total amount of our export sales from our Israel
facilities to countries outside of Israel was approximately $7.8 million, or 18%
of our total sales.

Legal Proceedings

      In June 2000, Rapiscan Security Products Inc. filed a suit against us
claiming $1.6 million in damages under an agreement between us and Rapiscan. We
have denied any liability, and have asserted that Rapiscan did not fulfill its
obligations under the agreement. In addition, we asserted that we are entitled
to approximately $1.8 million that is owed to us under a different transaction,
out of which approximately $417,000 may be offset by Rapiscan, and we have filed
a counter claim for the approximately $1.35 million balance owed to us. We have
recorded an accrual of approximately $1.2 million with respect to this suit.


                                       57
<PAGE>

      During 2002, several administrative petitions were filed against us by
competitors concerning our winning, on September 2002, the tenders published by
the MOD for the installation of intrusion detection systems along the seam line
between Israel and the West Bank. The main claim was that the conditions for the
tenders gave us an advantage. We have defended these petitions claiming, among
others, that the competitors delayed in filing their claim. The court refused to
issue any interim decree preventing us from commencing our work and the decision
was upheld by the Supreme Court of Israel. Only one of these claims is still
pending and awaits the court resolution of certain preliminary matters.
According to our legal counsel, we have good defenses against the aforementioned
claims, therefore, no allowance was recorded in the financial statements.

      In April 2003, Rav-Tec Ltd. filed a civil action against us, the MOD and
Mr. Giora Cohen, in the District Court of Tel-Aviv. The plaintiff alleges that
its failure in the field trials of the perimeter systems executed by the MOD
during 1996-1997 resulted from intentional damage to its fence and diversion of
the results of certain intrusion tests made by Cohen who was then a soldier in
the IDF. The plaintiff alleges that we were the employer of Cohen during 1995
and we still employed him as our agent during the field trials. The plaintiff
requests the courts to annul the field trial and for approximately $730,000 in
damages. We have denied all of the above allegations and claimed that the
plaintiff's perimeter system failure was not the result of Cohen actions.
According to our legal counsel, we have good defenses against the aforementioned
claims. The action is in its preliminary stages.

      In addition, we are subject to legal proceedings arising in the normal
course of business. Based on the advice of our legal counsel, management
believes that these proceedings will not have a material adverse effect on our
financial position or results of operations.

Dividend Policy

      In 1998, we changed our dividend payment policy to pay annual dividends on
our ordinary shares equal to between 25% and 33% of our net profits for the
previous fiscal year. We implemented this policy change because we had
accumulated sufficient cash and our operations had been generating a positive
cash flow.

      In each of 1999 and 2000, we paid a cash dividend to our shareholders of
$0.10 per ordinary share, representing approximately 32% of our net income
before writing off the investment in our affiliate in each of 1998 and 1999. In
2001, we paid a cash dividend to our shareholders of $0.13 per ordinary share,
representing approximately 33% of our net income in 2000. In August 2002, we
paid a 3% stock dividend to our shareholders of record as of August 1, 2002 as a
final dividend for the year ended December 31, 2001.

      In May 2003, our Board of Directors decided to distribute a 3% stock
dividend. This decision has not yet been approved by the annual general meeting
of shareholders.

B. Significant Changes.

      Except as otherwise disclosed in this annual report, there has been no
material change in our financial position since December 31, 2002.


                                       58
<PAGE>

ITEM 9. The Offer and Listing

A. Offer and Listing Details

Annual Stock Information

      The following table sets forth, for each of the years indicated, the range
of high ask and low bid prices of our ordinary shares on the Nasdaq National
Market and the Tel Aviv Stock Exchange:

                    Nasdaq National Market        Tel Aviv Stock Exchange*
                    ----------------------        ------------------------
                      High           Low             High             Low
                      ----           ---             ----             ---
Year
----
1998 .........      $ 3.7813      $ 1.6875       NIS    --       NIS    --
1999 .........        3.9375        2.1875              --              --
2000 .........        4.825         2.8125              --              --
2001 .........       14.24          2.9375           64.00           20.50
2002 .........       13.49          4.57             59.60           22.24

----------
*     Our ordinary shares began trading on the Tel Aviv Stock Exchange on July
      1, 2001. The share prices on the Tel Aviv stock exchange are in NIS. The
      representative exchange rate between the NIS and the dollar as published
      by the Bank of Israel on June 17, 2003 was NIS 4.353 per $1.00.

Quarterly Stock Information

      The following table sets forth, for each of the full financial quarters in
the years indicated, the range of high ask and low bid prices of our ordinary
shares on the Nasdaq National Market and the Tel Aviv Stock Exchange:

                    Nasdaq National Market        Tel Aviv Stock Exchange*
                    ----------------------        ------------------------
                      High           Low             High             Low
                      ----           ---             ----             ---
2001
----
First Quarter ...   $ 4.4375      $ 2.9375       NIS    --       NIS    --
Second Quarter ..     6.60          4.00                --              --
Third Quarter ...    10.70          4.99             44.14           20.50
Fourth Quarter ..    14.24          7.18             64.00           30.15

2002
----
First Quarter ...    13.49          8.50             59.60           40.50
Second Quarter ..    12.80          8.50             59.40           43.00
Third Quarter ...    11.65          5.95             53.40           30.64
Fourth Quarter ..     6.93          4.57             31.90           22.24

----------
*     Our ordinary shares began trading on the Tel Aviv Stock Exchange on July
      1, 2001. The share prices on the Tel Aviv stock exchange are in NIS. The
      representative exchange rate between the NIS and the dollar as published
      by the Bank of Israel on June 17, 2003 was NIS 4.353 per $1.00.

Monthly Stock Information

      The following table sets forth, for each month in the last six months of
2002, the range of high ask and low bid prices of our ordinary shares on the
Nasdaq National Market and the Tel Aviv Stock Exchange:


                                       59
<PAGE>

                              Nasdaq National Market    Tel Aviv Stock Exchange*
                              ----------------------    ------------------------
                                High          Low            High           Low
                                ----          ---            ----           ---
2002
----
July ...................      $  11.65      $   7.20    NIS  53.40    NIS  36.75
August .................          9.20          7.62         41.36         36.32
September ..............          9.10          5.95         41.96         30.64
October ................          6.10          4.57         28.81         22.24
November ...............          6.93          5.20         31.28         24.54
December ...............          6.80          5.20         31.90         25.01

----------
*     Our ordinary shares began trading on the Tel Aviv Stock Exchange on July
      1, 2001. The share prices on the Tel Aviv stock exchange are in NIS. The
      representative exchange rate between the NIS and the dollar as published
      by the Bank of Israel on June 17, 2003 was NIS 4.353 per $1.00.

B. Plan of Distribution

      Not applicable.

C. Markets

      Our ordinary shares have traded on the Nasdaq National Market under the
symbol MAGS since our initial public offering in 1993. As of July 1, 2001, our
ordinary shares are also traded on the Tel Aviv Stock Exchange under the symbol
MAGS.

D. Selling Shareholders

      Not applicable.

E. Dilution

      Not applicable.

F. Expenses of the Issue

      Not applicable.

ITEM 10. Additional Information

A. Share Capital.

      Not applicable.

B. Memorandum and Articles of Association.

      We are registered with the Israeli Companies Registry and have been
assigned company number 52-003892-8. Section 2 of our memorandum of association
provides, among other things, that we were established for the purposes of
acquiring from IAI a plant, known as the Magal Plant, engaged in the
development, manufacture, sale and support of alarm devices and dealing in the
development, manufacturing and support of security alarm devices and other
similar products. In addition, the purpose of our company is to be eligible to
perform and act in connection with any right or obligation of whatever kind or
nature permissible under Israeli law.


                                       60
<PAGE>

      On February 1, 2000, the Companies Law, came into effect and superseded
most of the provisions of the Israeli Companies Ordinance (New Version),
5743-1983, except for certain provisions which relate to bankruptcy, dissolution
and liquidation of companies. The Companies Law authorizes the Minister of
Justice to adopt regulations exempting from the provisions of the Companies Law,
certain of which are described below, companies, such as us, whose shares are
traded outside of Israel. Under the Companies Law, various provisions of such
law, some of which are detailed below, overrule the current provisions of our
articles of association.

Board of Directors

      The strategic management of our business (as distinguished from the daily
management of the our business affairs) is vested in our board of directors,
which may exercise all such powers and do all such acts as our company is
authorized to exercise and do, and which are not required to be exercised by a
resolution of the general meeting of our shareholders. The board of directors
may, subject to the provisions of the Companies Law, delegate some of its powers
to committees, each consisting of one or more directors, provided that at least
one member of such committee is an external director.

      According to the Companies Law, we may stipulate in our articles of
association that the general meeting of shareholders is authorized to assume the
responsibilities of the board of directors. In the event the board of directors
is unable to act or exercise its powers, the general meeting of shareholders is
authorized to exercise the powers of the board of directors, although the
articles of association do not stipulate so. Our board of directors has the
power to assume the responsibilities of our chief executive officer if he is
unable to act or exercise his powers or if he fails to fulfill the instructions
of the board of directors with respect to a specific matter.

      Our articles of association do not impose any mandatory retirement or
age-limit requirements on our directors and our directors are not required to
own shares in our company in order to qualify to serve as directors.

      For a discussion of the Companies Law regulations concerning a director's
duty of care and duty of loyalty, see Item 6.C. "Directors, Senior Management
and Employees-Board Practices-Approval of Specific Related-Party Transactions."
For a discussion of the Companies Law regulations regarding indemnification of
directors, see Item 6.C. "Directors, Senior Management and Employees-Board
Practices-Indemnification of Directors and Officers and Limitations of
Liability."

      Directors' compensation arrangements (other than external directors)
require the approval of our audit committee before board and shareholder
approval. However, pursuant to recent amendments to the Companies Regulations
(Relief from Related Party Transactions), 5760-2000, directors' compensation and
employment arrangements do not require shareholder approval if both the audit
committee and the board of directors agree that such arrangements are solely for
the benefit of the company. In addition, if the director is a controlling
shareholder of the company, then the employment and compensation arrangements of
such director do not require shareholder approval; provided such arrangements
meet certain specified criteria.

      The relief from having to obtain shareholder approval set forth above will
not apply, and shareholder approval will be required, if one or more
shareholders, holding at least 1% of the issued and outstanding share capital of
the company or of the company's voting rights, object to the grant of such
relief, provided that such objection is submitted to the company in writing not
later than seven days from the date of the filing of a report regarding the
adoption of such resolution by the company pursuant to the requirements of the
Israeli Securities Law (which reporting requirements are not applicable to us as
a double foreign company).


                                       61
<PAGE>

      The board of directors may from time to time, at its discretion, cause the
company to borrow or secure the payment of any money for the purposes of the
company, and may secure or provide for the repayment of such money in the manner
as it deems fit.

Share Capital

      Our share capital consists of NIS 19,748,000 divided into 19,748,000
ordinary shares, par value NIS 1.00 each, all ranking pari passu. All our
ordinary shares have the same rights, preferences and restrictions, some of
which are detailed below. At the general meeting of shareholders, our
shareholders may, subject to certain provisions detailed below, create different
classes of shares, each class bearing different rights, preferences and
restrictions.

      Dividends

      Holders of ordinary shares are entitled to participate in the payment of
dividends in accordance with the amounts paid-up or credited as paid up on the
nominal value of such ordinary shares at the time of payment (without taking
into account any premium paid thereon). However, under article 13 of our
articles of association no shareholder shall be entitled to receive any
dividends until he shall have paid all calls then currently due and payable on
each ordinary share held by such shareholder.

      Declaration of a final dividend requires the approval by ordinary
resolution of our shareholders at a general meeting of shareholders. Such
resolution may reduce but not increase the dividend amount recommended by the
board of directors. Dividends may be paid, in whole or in part, by way of
distribution of dividends in kind.

      Dividends may be paid only out of our distributable earnings, as defined
in the Companies Law. Prior to any distribution of dividends, our board of
directors has to determine that there is no reasonable concern that such
distribution will prevent us from executing our existing and foreseeable
obligations as they become due.

      Voting Rights

      Holders of ordinary shares are entitled to one vote for each share of
record on all matters submitted to a vote of shareholders. Voting is done by a
show of hands, unless a poll is demanded prior to a vote by a show of hands.
Generally, resolutions are adopted at the general meeting of shareholders by an
ordinary resolution, unless the Companies Law or the articles of association
require an extraordinary resolution.

      An ordinary resolution, such as a resolution approving the declaration of
dividends or the appointment of auditors, requires approval by the holders of a
simple majority of the shares represented at the meeting, in person or by proxy,
and voting thereon. An extraordinary resolution requires approval by the holders
of at least 75% of the shares represented at the meeting, in person or by proxy,
and voting thereon.

      The primary resolutions required to be adopted by an extraordinary
resolution of the general meeting of shareholders are resolutions to:

o     amend the memorandum or the articles of association;

o     change the share capital, for example, increasing or canceling the
      authorized share capital or modifying the rights attached to shares; and


                                       62
<PAGE>

o     approve mergers, consolidations or winding up of our company.

      Our articles of association do not contain any provisions regarding a
classified board of directors or cumulative voting for the election of
directors.

      Rights in the Company's Profits

      Our shareholders have the right to share in our profits distributed as a
divdend or any other permitted distributions.

      Liquidation

      Article 111 of our articles of association provides that upon any
liquidation, dissolution or winding-up of our company, our remaining assets
shall be distributed pro-rata to our ordinary shareholders.

      Redemption

      Under article 38 of our articles of association we may issue redeemable
stock and redeem the same.

      Transfer of shares

      The transfer of a fully paid-up ordinary share does not require the
approval of our board of directors. However, according to article 17 of our
articles of association, any transfer of an ordinary share requires an
instrument of transfer in the form designated by the board of directors together
with any other evidence of title as the board of directors may reasonably
request.

      Substantial limitations on shareholders

      See Item 6.C. "Directors, Senior Management and Employees-Board
Practices-Approval of Specific Related-Party Transactions."

      Capital Calls

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

Modifications of Share Rights

      Shares, which confer preferential or subordinate rights relating to, among
other things, dividends, voting, and payment of capital may be created only by
an extraordinary resolution of the general meeting of shareholders. The rights
attached to a class of shares may be altered by an extraordinary resolution of
the general meeting of shareholders, provided the holders of 75% of the issued
shares of that class approve such change by the adoption of an extraordinary
resolution at a separate meeting of such class, subject to the terms of such
class. The provisions of the articles of association pertaining to general
meetings of shareholders also apply to a separate meeting of a class of
shareholders.

General Meetings of Shareholders

      An annual general meeting of shareholders is held at least once every
calendar year, not later than 15 months after the last annual general meeting of
shareholders, at such time and at such place as may be fixed by the board of
directors. Any additional general meetings of


                                       63
<PAGE>

shareholders are called "extraordinary general meetings." The board of directors
may, in its discretion, convene an extraordinary general meeting and is obliged
to do so upon receipt of a written request from the holders of at least 5% of
our outstanding ordinary shares and/or of our voting rights.

      The Companies Law provides that a company whose shares are traded on a
stock exchange must give notice of a general meeting of shareholders to its
shareholders of record at least twenty-one days prior to the meeting. A
shareholder present, in person or by proxy, at the commencement of a general
meeting of shareholders may not seek the cancellation of any proceedings or
resolutions adopted at such general meeting of shareholders on account of any
defect in the notice of such meeting relating to the time or the place thereof.
Shareholders who are registered in our register of shareholders at the record
date may vote at the general meeting of shareholders. The record date is set in
the resolution to convene the general meeting of shareholders, provided,
however, that such record date must be between four to twenty-one days or, in
the event of a vote by ballots, between four to forty days before the date the
general meeting of shareholders is held.

      The quorum required for a general meeting of shareholders consists of at
least two record shareholders, present in person or by proxy, who hold, in the
aggregate, at least one third of the voting power of our outstanding shares. A
general meeting of shareholders will be adjourned for lack of a quorum after
half an hour from the time appointed for such meeting to the same day in the
following week at the same time and place or any other time and place as the
board of directors designates in a notice to the shareholders. At such
reconvened meeting, if a quorum is not present within half an hour from the time
appointed for such meeting, two or more shareholders, present in person or by
proxy, will constitute a quorum. The only business that may be considered at an
adjourned general meeting of shareholders is the business that might have been
lawfully considered at the general meeting of shareholders originally convened
and the only resolutions that may be adopted are the resolutions that could have
been adopted at the general meeting of shareholders originally convened.

Limitations on the Right to Own Our Securities

      Neither our memorandum or articles of association nor the laws of the
State of Israel restrict in any way the ownership or voting of our ordinary
shares by non-residents, except that the laws of the State of Israel may
restrict the ownership of ordinary shares by residents of countries that are in
a state of war with Israel.

Provisions Restricting a Change in Control of Our Company

      The Companies Law requires that mergers between Israeli companies be
approved by the board of directors and general meeting of shareholders of both
parties to the transaction. The approval of the board of directors of both
companies is subject to such board of directors' confirmation that there is no
reasonable doubt that after the merger the surviving company will be able to
fulfill its obligations to its creditors. Each company must notify its creditors
about the contemplated merger. Under the Companies Law, our articles of
association are deemed to include a requirement that such merger be approved by
an extraordinary resolution of our shareholders, as explained above. The
approval of the merger by the general meetings of shareholders of each of the
companies is also subject to additional approval requirements as specified in
the Companies Law and regulations promulgated thereunder.

      The Companies Law also provides that an acquisition of shares in a public
company on the open market must be made by means of a tender offer if as a
result of the acquisition the purchaser would become a 25% shareholder of the
company. However, this rule does not apply if


                                       64
<PAGE>

there already is another 25% shareholder of the company. Similarly, if there
already is another shareholder who holds more than 25% but less than 50% of the
company's outstanding share capital, an acquisition of shares in a public
company on the open market must be made by means of a tender offer, if as a
result of the acquisition the purchaser would become a 45% shareholder of the
Company. However, under the Companies Law, if following any acquisition of
shares the acquirer would hold 90% or more of the company's shares, the
acquisition must be made by means of a tender offer for all of the shares of the
class. These rules do not apply if the acquisition is made by way of a private
placement. In addition, these rules do not apply to a company whose shares are
publicly traded outside of Israel if applicable foreign securities laws restrict
the acquisition of any level of control of the company or require the purchaser
to make a tender offer to the public shareholders upon the acquisition of any
level of control of the company.

Disclosure of Shareholders' Ownership

      The Israeli Securities Law, 5728-1968 and regulations promulgated
thereunder contain various provisions regarding the ownership threshold above
which shareholders must disclose their share ownership. However, these
provisions do not apply to companies, such as ours, whose shares are publicly
traded in Israel as well as outside of Israel. As a result of the listing of our
ordinary shares on the Tel Aviv Stock Exchange, we are required pursuant to the
Israeli Securities Law and the regulations promulgated thereunder to deliver to
the Israeli Share Registrar, the Israeli Securities Exchange Commission and the
Tel Aviv Stock Exchange, all reports, documents, forms and information received
by us from our shareholders regarding their shareholdings, provided that such
information was published or required to be published under applicable foreign
law.

C. Material Contracts.

      We are not a party to any material contracts other than those entered into
in the ordinary course of business.

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 such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.

      Non-residents of Israel who purchase our ordinary shares will be able to
convert dividends, if any, thereon, 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, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.

E. Taxation

      The following is a summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us and our
shareholders. The following also contains a discussion of Israeli government
programs benefiting us. To the extent that the discussion is based on new tax
legislation that has not been subject to judicial or administrative
interpretation, we cannot assure you that the tax authorities will accept the
views expressed in the discussion in


                                       65
<PAGE>

question. The discussion is not intended, and should not be taken, as legal or
professional tax advice and is not exhaustive of all possible tax
considerations.

Tax Reform

      On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No.132), 5762-2002, known as the Tax Reform, came into effect,
following its enactment by the Israeli Parliament on July 24, 2002. On December
17, 2002, the Israeli Parliament approved a number of amendments to the tax
reform, which came into effect on January 1, 2003.

      The tax reform, aimed at broadening the categories of taxable income and
reducing the tax rates imposed on employment income, introduced the following,
among other things:

o     Reduction of the tax rate levied on capital gains (other than gains
      deriving from the sale of listed securities) derived after January 1,
      2003, to a general rate of 25% for both individuals and corporations.
      Regarding assets acquired prior to January 1, 2003, the reduced tax rate
      will apply to a proportionate part of the gain, in accordance with the
      holding periods of the asset, before or after January 1, 2003, on a linear
      basis;

o     Imposition of Israeli tax on all income of Israeli residents, individuals
      andorporations, regardless of the territorial source of income, including
      income derived from passive sources such as interest, dividends and
      royalties;

o     Introduction of controlled foreign corporation (CFC) rules into the
      Israeli tax structure. Generally, under such rules, an Israeli resident
      who holds, directly of indirectly, 10% or more of the rights in a foreign
      corporation whose shares are not publicly traded, in which more than 50%
      of the rights are held directly or indirectly by Israeli residents, and a
      majority of whose income in a tax year is considered passive income, will
      be liable for tax on the portion of such income attributed to his holdings
      in such corporation, as if such income were distributed to him as a
      dividend;

o     Imposition of capital gains tax on capital gains realized by individuals
      as of January 1, 2003, from the sale of shares of publicly traded
      companies (such gain was previously exempt from capital gains tax in
      Israel). For information with respect to the applicability of Israeli
      capital gains taxes on the sale of ordinary shares, see "Capital Gains Tax
      on Sales of Our Ordinary Shares" below; and

o     Introduction of a new regime for the taxation of shares and options issued
      to employees and officers (including directors).

General Corporate Tax Structure

      Israeli companies are subject to company tax at a rate of 36% of taxable
income. However, the effective tax rate payable by a company that derives income
from an approved enterprise, discussed further below, may be considerably less.
See "-Law for the Encouragement of Capital Investments, 1959." Subject to
relevant tax treaties, dividends or interest received by an Israeli company from
its foreign subsidiaries are generally subject to tax regardless of such
company's status as an approved enterprise.

Law for the Encouragement of Industry (Taxes), 1969

      According to the Law for the Encouragement of Industry (Taxes), 1969,
generally referred to as the Industry Encouragement Law, an industrial company
is a company resident in


                                       66
<PAGE>

Israel, at least 90% of the income of which, in a given tax year, determined in
Israeli currency exclusive of income from specified government loans, capital
gains, interest and dividends, is derived from an industrial enterprise owned by
it. An industrial enterprise is defined as an enterprise whose major activity in
a given tax year is industrial production activity.

      Under the Industry Encouragement Law, industrial companies are entitled to
the following preferred corporate tax benefits:

o     deduction of purchases of know-how and patents over an eight-year period
      for tax purposes, at a rate of 12.5% per year;

o     deduction of specified expenses incurred for a public issuance of
      securities over a three-year period for tax purposes;

o     right to elect, under specified conditions, to file a consolidated tax
      return with additional related Israeli industrial companies; and

o     accelerated depreciation rates on equipment and buildings.

      Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority.

      We believe that we currently qualify as an industrial company as defined
by the Industry Encouragement Law. We cannot assure you that we will continue to
qualify as an industrial company or that the benefits described above will be
available to us in the future.

Law for the Encouragement of Capital Investments, 1959

      General

      The Law for the Encouragement of Capital Investments, 1959, commonly
referred to as the Investment Law, provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the
Ministry of Industry and Trade of the State of Israel, commonly referred to as
the Investment Center, be designated as an approved enterprise. Each certificate
of approval for an approved enterprise relates to a specific investment program
delineated both by its financial scope, including its capital sources, and by
its physical characteristics, for example, the equipment to be purchased and
utilized under the program. The tax benefits derived from any certificate of
approval relate only to taxable income attributable to the specific approved
enterprise. If a company has more than one approval or only a portion of its
capital investments is approved, its effective tax rate is the result of a
weighted average of the applicable rates.

      Certain of our production facilities have been granted approved enterprise
status pursuant to the Investment Law, which provides certain tax and financial
benefits to investment programs that have been granted this status.

      Tax Benefits

      Taxable income of a company derived from an approved enterprise is
generally subject to company tax at the maximum rate of 25%, rather than 36%,
for the benefit period. This period is ordinarily seven years, or ten years if
the company qualifies as a foreign investors' company as described below,
commencing with the year in which the approved enterprise first generates


                                       67
<PAGE>

taxable income. However, this period is limited to the earlier of twelve years
from commencement of production or fourteen years from the date of approval.

      A company that owns an approved enterprise may elect to receive an
alternative package of benefits. Under the alternative package of benefits, a
company's undistributed income derived from an approved enterprise will be
exempt from company tax for a period of between two and ten years from the first
year of taxable income, depending on the geographic location of the approved
enterprise within Israel, and the company will be eligible for a reduced tax
rate for the remainder of the benefits period.

      A company that has an approved enterprise program is eligible for further
tax benefits if it qualifies as a foreign investors' company. A foreign
investors' company is a company more than 25% of whose share capital and
combined share and loan capital is owned by non-Israeli residents. A company
that qualifies as a foreign investors' company and has an approved enterprise
program is eligible for tax benefits for a ten year benefit period. Income
derived from the approved enterprise program will be exempt from tax for a
period of two years and will be subject to a reduced tax rate for an additional
eight years, provided that the company qualifies as a foreign investors'
company. The tax rate for the additional eight-year period is 25%. However, if
the level of foreign investment exceeds 49% but is less than 74%, then the tax
rate for the additional eight-year period is 20%. If the level of foreign
investment exceeds 74% but is less than 90%, then the tax rate for the
additional eight-year period is 15%. If the level of foreign investment exceeds
90%, then the tax rate for the additional eight-year period is 10%. If the
company does not qualify as a foreign investors' company, the period of the
reduced tax rate will be five years.

      A company that has elected the alternative package of benefits and that
subsequently pays a dividend out of income derived from the approved enterprise
during the tax exemption period will be subject to tax on the amount distributed
at the rates mentioned above. The tax rate will be the rate that would have been
applicable had the company not elected the alternative package of benefits. This
rate is generally 10%-25%, depending on the percentage of the company's shares
held by foreign shareholders. The dividend recipient is taxed at the reduced
rate applicable to dividends from approved enterprises, which is 15% if the
dividend is distributed during the tax exemption period or within 12 years after
the period. The company must withhold this tax at the source, regardless of
whether the dividend is converted into foreign currency.

      Subject to applicable provisions concerning income under the alternative
package of benefits, all incomes are considered to be attributable to the entire
enterprise and their effective tax rate is the result of a weighted average of
the various applicable tax rates. Under the Investment Law, a company that has
elected the alternative package of benefits is not obliged to distribute exempt
retained profits, and may generally decide from which year's profits to declare
dividends.

      The benefits available to an approved enterprise program are dependent
upon the fulfillment of conditions stipulated in applicable law and in the
certificate of approval. If we fail to comply with these conditions with regard
to our approved enterprises, the tax and other benefits we receive could be
rescinded, in whole or in part, and we may be required to refund the amount of
previously received benefits in addition to Israeli CPI linkage adjustments and
interest costs. We believe that our approved enterprises currently substantially
comply with all such conditions.


                                       68
<PAGE>

      Financial Benefits

      An approved enterprise is also entitled to a grant from the Government of
Israel for investments in certain production facilities located in designated
areas within Israel, provided it did not elect the alternative benefits program.
Grants are available for enterprises situated in development areas and for
high-technology or skill-intensive enterprises in Jerusalem. The investment
grant is computed as a percentage of the original cost of the fixed assets for
which the approved enterprise has been granted.

      From time to time, the Government of Israel has discussed reducing the
benefits available to companies under the Investment Law. In 1996, the
investment grant was decreased from 38% to 34% and in January 1997 the grant was
reduced to 20%. Currently, grants generally range between 10% and 20%. If the
benefits available under the Investment Law are terminated or substantially
reduced, it could have a material adverse effect on our future investments in
Israel.

      For companies such as ours, whose foreign shareholders exceed 25% of the
company's outstanding ordinary shares, future approved enterprises would entitle
such companies to receive reduced tax rates for up to ten tax years, rather than
the maximum seven tax years applicable to companies with a smaller foreign
investment.

      As long as we are in compliance with the conditions set forth in the
certificates of approval granted to us, our income derived from our approved
enterprise expansion programs will be tax exempt for the prescribed period and
thereafter will enjoy reduced tax rates as detailed above. If we violate these
conditions, we may be required to refund the amount of tax benefits we
previously received in addition to Israeli CPI linkage adjustments and interest
costs.

      We currently have three approved enterprise expansion programs which were
approved in 1992, 1997 and 2001, respectively, and under which we are entitled
to tax benefits. The periods of benefits for two of our approved enterprise
programs will expire in 2003 and 2007, respectively, and the period of benefits
for our third approved enterprise program has not yet begun. The benefits we
receive in connection with our approved enterprise programs are conditioned upon
the fulfillment of a marketing plan filed by us with the Investment Center.

Law for the Encouragement of Industrial Research and Development, 1984

      Under the Law for the Encouragement of Industrial Research and
Development, 1984, commonly referred to as the Research Law, research and
development programs that meet specified criteria and are approved by a
governmental committee of the OCS are eligible for grants of generally up to 50%
of the project's expenditures, as determined by the research committee, in
exchange for the payment of royalties from the sale of products developed under
the program. Regulations under the Research Law generally provide for the
payment of royalties to the OCS of 3%-5% on sales of products and services
derived from technology developed using these grants until all of the
dollar-linked grant is repaid. Upon full repayment of the grant, there is no
further liability for royalties.

      The terms of the Israeli government participation also require that
products developed with government grants must be manufactured in Israel.
However, under the regulations of the Research Law, if any of the manufacturing
is performed outside of Israel by any entity other than us, assuming we receive
approval from the OCS for the foreign manufacturing, we may be required to pay
increased royalties. The increase in royalties depends upon the manufacturing
volume that is performed outside of Israel as follows:


                                       69
<PAGE>

      Manufacturing volume            Royalties to the Chief Scientist
       outside of Israel                  as a percentage of grant
      --------------------            --------------------------------
         less than 50%                              120%
      between 50% and 90%                           150%
         more than 90%                              300%

      Under the Research Law, the technology developed with OCS grants may not
be transferred to third parties without the prior approval of a governmental
committee. However, such approval is not required to export any products
developed using the grants. Approval of the transfer of technology may be
granted in specific circumstances if the recipient abides by the provisions of
the Research Law and related regulations, including the restrictions on the
transfer of know-how and the obligation to pay royalties in an amount that may
be increased. We cannot assure you that any consent, if requested, will be
granted.

      Effective for grants received from the OCS under programs approved after
January 1, 1999, the outstanding balance of the grants will be subject to
interest equal to the 12-month LIBOR applicable to dollar deposits that is
published on the first business day of each calendar year.

      The funds generally available for grants by the OCS were reduced for 2003,
and the Israeli authorities have indicated that the government may further
reduce or abolish grants from the OCS in the future. Even if these grants are
maintained, we cannot assure you that we will receive OCS grants in the future.
In addition, each application to the OCS is reviewed separately, and grants are
based on the program approved by the research committee. Generally, expenditures
supported under other incentive programs of the State of Israel are not eligible
for grants from the OCS.

Taxation Under Inflationary Conditions

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

o     There is a special tax adjustment for the preservation of equity as
      follows:

      o     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.

      o     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.

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

o     Gains on traded securities, which are normally exempt from tax, are
      taxable in specified circumstances. However, securities dealers are
      subject to the regular tax rules applicable to business income in Israel.


                                       70
<PAGE>

      Pursuant to the Inflationary Adjustments Law, results for tax purposes are
measured in real terms in accordance with changes in the Israeli CPI. The
discrepancy between the change in the Israeli 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
dollars as reflected in our financial statements (see note 14 of the notes to
our consolidated financial statements). A foreign investors' company may,
subject to certain conditions, elect to measure results, for tax purposes, in
dollar terms.

Capital Gains Tax

      Israeli law generally imposes a capital gains tax on the sale of capital
assets located in Israel, including shares in Israeli companies, by both
residents and non-residents of Israel. Unless a Specific exemption is available
or unless a tax treaty between Israel and the shareholder's country of residence
provides otherwise. The law distinguishes between real gain and inflationary
surplus. The inflationary surplus is a portion of the total capital gain which
is equivalent to the increase of the relevant asset's purchase price which is
attributable to the increase in the Israeli consumer price index between the
date of purchase and the date of sale. The real gain is the excess of the total
capital gain over the inflationary surplus.

      Prior to the tax reform, sales of our ordinary shares by individuals were
generally exempt from Israeli capital gains tax for so long as they were quoted
on Nasdaq or listed on a stock exchange in a country appearing in a list
approved by the Controller of Foreign Currency and we qualified as an Industrial
Company. The above was also applicable following the dual listing of our shares
in the Israeli Stock Exchange.

      Pursuant to the tax reform, generally, capital gains tax is imposed at a
rate of 15% on real gains derived on or after January 1, 2003, from the sale of
shares in companies (i) publicly traded on the Tel Aviv Stock Exchange ("TASE")
or; (ii) (subject to a necessary determination by the Israeli Minister of
Finance) Israeli companies publicly traded on a recognized stock exchange
outside of Israel (such as MAGAL).

      This tax rate does not apply to: (i) dealers in securities; (ii)
shareholders that report in accordance with Chapter B to the Inflationary
Adjustment Law; or (iii) shareholders who acquired their shares prior to an
initial public offering (that are subject to a different tax arrangement).

      The tax basis of shares acquired prior to January 1, 2003 will be
determined in accordance with the average closing share price in the three
trading days preceding January 1, 2003. However, a request may be made to the
tax authorities to consider the actual adjusted cost of the shares as the tax
basis if it is higher than such average price.

      Non-Israeli residents are exempt from Israeli capital gains tax on any
gains derived from the sale of shares publicly traded on a the TASE, and are
exempt from Israeli capital gains tax on any gains derived from the sale of
shares of Israeli companies publicly traded on a recognized stock exchange
outside of Israel, provided however that such capital gains are not derive from
a permanent establishment in Israel and provided that such shareholders did not
acquire their shares prior to an initial public offering.

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


                                       71
<PAGE>

      In any event, the provisions of the tax reform will not affect the
exemption from capital gains tax for gains accrued before January 1, 2003, as
described above. In some instances where our shareholders may be liable for
Israeli tax on the sale of their ordinary shares, the payment of the
consideration may be subject to the withholding of Israeli tax at the source.

      Pursuant to the Convention between the governments of the United States of
America and Israel with respect to taxes on income, as amended, or the
"U.S.-Israel Tax Treaty", the sale, exchange or disposition of ordinary shares
by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies
as a resident of the United States within the meaning of the U.S.-Israel Tax
Treaty and (iii) is entitled to claim the benefits afforded to such person by
the U.S.-Israel Tax Treaty generally will not be subject to the Israeli capital
gains tax unless such Treaty U.S. Resident holds, directly or indirectly, shares
representing 10% or more of our voting power during any part of the 12-month
period preceding such sale, exchange or disposition, subject to certain
conditions. In this case, the sale, exchange or disposition of ordinary shares
would be subject to Israeli tax, to the extent applicable; however, under the
U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be permitted to claim a
credit for such taxes against the U.S. federal income tax imposed with respect
to such sale, exchange or disposition, subject to the limitations in U.S. laws
applicable to foreign tax credits.

Taxation of Non-Resident Holders of Shares

      Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends other than bonus
shares, or stock dividends, income tax at the rate of up to 25% is withheld at
source, unless a different rate is provided in a treaty between Israel and the
shareholder's country of residence. Under the U.S.-Israel Tax Treaty, the
maximum tax on dividends paid to a holder of ordinary shares who is a Treaty
U.S. Resident is 25%. However, under the Investment Law, dividends generated by
an Approved Enterprise are taxed at the rate of 15%. Furthermore, dividends not
generated by an Approved Enterprise paid to a U.S. company holding 10% or more
of our ordinary shares are taxed at a rate of 12.5%.

      Under an amendment to the Inflationary Adjustments Law, non-Israeli
corporations might be subject to Israeli taxes on the sale of traded securities
of an Israeli company, subject to the provisions of any applicable double
taxation treaty or unless a specific exemption is available.

      For information with respect to the applicability of Israeli capital gains
taxes on the sale of ordinary shares by United States residents, see above
"-- Capital Gains Tax on Sales of Our Ordinary Shares."

United States Federal Income Tax Considerations

      Subject to the limitations described below, the following discussion
describes the material U.S. federal income tax consequences to a beneficial
owner of our ordinary shares, referred to for purposes of this discussion as a
"U.S. holder", that is:

o     a citizen or resident of the U.S.;

o     a corporation (or other entity treated as a corporation for U.S. federal
      tax purposes) created or organized in the U.S. or under the laws of the
      U.S. or of any U.S. state;


                                       72
<PAGE>

o     an estate, the income of which is includible in gross income for U.S.
      federal income tax purposes regardless of its source; or

o     a trust, if a court within the U.S. 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 U.S. federal income tax relevant
to a beneficial owner of our ordinary shares other than a U.S. holder, referred
to as a "Non-U.S. holder," are discussed below.

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

      This discussion is based on current provisions of the U.S. Internal
Revenue Code of 1986, as amended, current and proposed U.S. 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 U.S. 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 U.S. federal income tax
consequences to U.S. holders that are subject to special treatment, including
U.S. holders that:

o     are broker-dealers, including dealers in securities or currencies, or
      insurance companies;

o     have elected mark-to-market accounting;

o     are tax-exempt organizations;

o     are financial institutions or "financial services entities";

o     hold ordinary shares as part of a straddle, hedge or conversion
      transaction with other investments;

o     are holders owning directly, indirectly or by attribution at least 10% of
      our voting power;

o     have a functional currency that is not the dollar; or

o     received ordinary shares as compensation.

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

      Additionally, the discussion does not consider the tax treatment of
partnerships or persons who hold ordinary shares through a partnership or other
pass-through entity or the possible application of U.S. federal gift or estate
tax.


                                       73
<PAGE>

      Each holder of our 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 our ordinary shares.

Taxation of Ordinary Shares

      Taxation of Dividends Paid On Our Ordinary Shares

      Subject to the discussion in "Tax Consequences If We Are a Passive Foreign
Investment Company" below, a U.S. holder will be required to include in gross
income as ordinary income the amount of any distribution paid on our 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 U.S. federal
income tax purposes. Distributions in excess of such earnings and profits will
be applied against and will reduce the U.S. holder's basis in the ordinary
shares and, to the extent in excess of such basis, will be treated as gain from
the sale or exchange of ordinary shares.

      Distributions of current or accumulated earnings and profits paid in
foreign currency to a U.S. holder will be includible in the income of a U.S.
holder in a dollar amount calculated by reference to the exchange rate on the
date the distribution is received. A U.S. holder that receives a foreign
currency distribution and converts the foreign currency into dollars subsequent
to receipt will have foreign exchange gain or loss based on any appreciation or
depreciation in the value of the foreign currency against the dollar, which will
generally be U.S. source ordinary income or loss.

      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 U.S. 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 individuals may still claim a credit against
their U.S. 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 be determined on an individual basis by each
shareholder. Distributions of current or accumulated earnings and profits will
be foreign source passive income for U.S. 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 the
pre-credit U.S. tax liability for the year attributable to foreign source
taxable 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.

      Taxation of the Disposition of Our Ordinary Shares

      Subject to the discussion in "Tax Consequences If We Are a Passive Foreign
Investment Company" below, upon the sale or exchange of our 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 dollar cost of such shares, and the amount realized on such sale or
exchange. As our ordinary shares are publicly traded, a sale or exchange of such
ordinary shares will be considered to occur on the trade date, regardless of the
U.S. holder's method of accounting. A U.S. holder that uses the cash method of
accounting calculates the dollar value of


                                       74
<PAGE>

the proceeds received on the sale as of the date that the sale settles. However,
a U.S. holder that uses the accrual method of accounting is required to
calculate the value of the proceeds of the sale as of the "trade date" and may
therefore realize foreign currency gain or loss, unless such U.S. holder has
elected to use the settlement date to determine its proceeds of sale for
purposes of calculating such foreign currency gain or loss. Capital gain from
the sale or exchange of ordinary shares held more than one year is long-term
capital gain. Gain or loss recognized by a U.S. holder on a sale or exchange of
ordinary shares will be treated as U.S. source income or loss for U.S. foreign
tax credit purposes. The deductibility of a capital loss recognized on the sale
or exchange of ordinary shares is subject to limitations. In addition, a U.S.
holder that receives foreign currency upon a sale or exchange of the ordinary
shares and converts the foreign currency into dollars subsequent to receipt will
have foreign exchange gain or loss based on any appreciation or depreciation in
the value of the foreign currency against the dollar, which will generally be
U.S. source ordinary income or loss.

      New Tax Law Applicable to Dividends and Long-Term Capital Gain

      Under recently enacted tax legislation, dividends received by individual
U.S. Holders from certain foreign corporations, and long-term capital gain
realized by individual U.S. Holders, generally are subject to a reduced maximum
tax rate of 15 percent through December 31, 2008. Dividends received with
respect to ordinary shares should qualify for the 15 percent rate. The reduced
rate on capital gains applies to sales and exchanges on or after May 6, 2003 and
the reduced rates on dividend income to dividends received after December 31,
2002. The rate reduction does not apply to dividends received in respect of
certain short-term or hedged positions in the common stock or in certain other
situations. The legislation contains special rules for computing the foreign tax
credit limitation of a taxpayer who receives dividends subject to the rate
reduction. U.S. Holders should consult their own tax advisors regarding the
implications of these rules in light of their particular circumstances.

      Tax Consequences If We Are a Passive Foreign Investment Company

      We will be a passive foreign investment company, or PFIC, for U.S. federal
income tax purposes if 75% or more of our gross income in a taxable year,
including the pro-rata share of the gross income of any company, U.S. or
foreign, in which we are considered to own 25% or more of the shares by value,
is passive income. Alternatively, we will be considered to be a PFIC if 50% or
more of our 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 we are 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 we are a PFIC, and a U.S. holder did
not make a qualifying election either to treat us as a "qualified electing fund"
(as described below) or mark our ordinary shares to market (as described below):

o     Excess distributions by us 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 our ordinary shares in any taxable year that exceed 125% of the
      average distributions received by such U.S. holder from us in the shorter
      of either the three previous years or such U.S. holder's holding period of
      the ordinary shares before the present taxable year. Excess distributions
      must be allocated ratably to each day that a U.S. holder has held our
      ordinary shares. A U.S. holder must include amounts allocated to the
      current taxable year 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
      at the highest rate in effect for that year on ordinary income


                                       75
<PAGE>

      and the tax is subject to an interest charge at the rate applicable to
      deficiencies for income tax.

o     The entire amount of gain realized by a U.S. holder upon the sale or other
      disposition of our ordinary shares will also be treated as an excess
      distribution and will be subject to tax as described above.

o     A U.S. holder's tax basis in our ordinary 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.

      If we are a PFIC, a U.S. holder of ordinary shares will be subject to the
PFIC rules as if such holder owned its pro-rata share of any of our direct or
indirect subsidiaries which are PFICs. Accordingly, a U.S. holder of our
ordinary shares will be subject to tax under the PFIC rules with respect to
distributions to us by, and dispositions by us of shares of, any direct or
indirect PFIC shares held by us, as if such holder received directly its
pro-rata share of either the distribution or proceeds from such disposition.

      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 we comply with certain reporting requirements. Instead, a shareholder of a
QEF is required for each taxable year to include in income a pro-rata share of
the ordinary earnings of the QEF as ordinary income and a pro-rata share of the
net capital gain of the QEF as long-term capital gain, subject to a separate
election to defer payment of taxes, which deferral is subject to an interest
charge. The QEF election is made on a shareholder-by-shareholder basis and can
be revoked only with the consent of the U.S. Internal Revenue Service, or IRS. A
shareholder makes a QEF election by attaching a completed IRS Form 8621 (using
the information provided in the PFIC annual information statement) to such
shareholder's timely filed U.S. federal income tax return. 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. We will not undertake to supply U.S. holders
with the information needed to report income and gain under a QEF election if we
were to be classified as a PFIC. In addition, we may not be able to provide such
information with respect to any directly or indirectly held PFIC shares.
Consequently, U.S. holders would be unable to make a QEF election with respect
to us or lower-tier PFIC shares and thus would be subject to the rules described
in the preceding paragraph with respect to distributions from or dispositions of
our shares or lower-tier PFIC shares.

      A U.S. holder of PFIC shares which are publicly traded could elect to mark
the shares 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 fair market value of the PFIC shares and the holder's adjusted tax basis in
the PFIC shares. 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.

      We believe that we were not a PFIC for 2002 and that we will not be a PFIC
for 2003. 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, we cannot assure you that
we will not become a PFIC. U.S. holders who hold our ordinary shares during a
period when we are a PFIC will be subject to the foregoing rules, even if we
cease to be a PFIC, subject to certain exceptions for U.S. holders who made a
QEF election. U.S. holders are strongly urged to consult their tax advisors
about the PFIC rules, including the


                                       76
<PAGE>

consequences to them of making a mark-to-market or QEF election with respect to
our ordinary shares in the event that we qualify as a PFIC.

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

      Except as described in "U.S. Information Reporting and Back-up
Withholding" below, a non-U.S. holder who is a beneficial owner of our 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, such ordinary
shares, unless:

o     such item is effectively connected with the conduct by the non-U.S. holder
      of a trade or business in the U.S. and, in the case of a resident of a
      country which has a treaty with the U.S., such item is attributable to a
      permanent establishment or, in the case of an individual, a fixed place of
      business, in the U.S.,

o     the non-U.S. holder is an individual who holds the ordinary shares as a
      capital asset and is present in the U.S. for 183 days or more in the
      taxable year of the disposition and does not qualify for an exemption, or

o     the non-U.S. holder is subject to tax pursuant to the provisions of U.S.
      tax law applicable to U.S. expatriates.

      U.S. Information Reporting and Back-up Withholding

      U.S. holders generally are subject to information reporting requirements
with respect to dividends paid in the U.S. on our ordinary shares. U.S. holders
are also subject to U.S. back-up withholding (currently at a rate of 30%) on
dividends paid in the U.S. on our ordinary shares unless the U.S. holder
provides an IRS Form W-9 or otherwise establishes an exemption. U.S. holders are
subject to information reporting and back-up withholding (currently at a rate of
30%) on proceeds paid from the disposition of our ordinary shares unless the
U.S. holder provides an 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 proceeds upon the
disposition of, our ordinary shares, provided that such 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. holder's or non-U.S. holder's U.S. 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. Statements by Experts.

      Not applicable.

H. Documents on Display.

      We are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, applicable to foreign private issuers and
fulfill the obligations with respect to such


                                       77
<PAGE>

requirements by filing reports with the Securities and Exchange Commission. You
may read and copy any document we file with the Securities and Exchange
Commission without charge at the Securities and Exchange Commission's public
reference room at 450 Fifth Street, N.W., Washington, D.C. 20549, and on the
Securities and Exchange Commission Internet site (http://www.sec.gov) and on our
website www.magal-ssl.com. Copies of such material may be obtained by mail from
the Public Reference Branch of the Securities and Exchange Commission at such
address, at prescribed rates. Please call the Securities and Exchange Commission
at l-800-SEC-0330 for further information on the public reference room.

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

I. Subsidiary Information.

      Not applicable.

ITEM 11. Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rate Risk

      Our exposure to market risk for changes in interest rates is related to
our long-term and short-term loans.

      Our financial expenses are sensitive primarily to LIBOR, since the
majority of our long-term loans bear a LIBOR-based interest rate.

      The table below presents principal amounts and related weighted average
interest rates by date of maturity for our loans:

                            Interest Rate Sensitivity
                      Principal Amount by Expected Maturity
                         Weighted Average Interest Rate
                         ------------------------------
                           (U.S. dollars in thousands)

<TABLE>
<CAPTION>
                                                                                                      Fair
                                                                                                    Value at
                                          2003         2004         2005        2006     Total      12/31/02
                                         ------       ------       ------       ----     ------      ------
<S>                                      <C>          <C>          <C>           <C>     <C>         <C>
Liabilities:
Short Term Loans ..................      $9,266           --           --        --      $9,266      $9,266
Weighted Average Interest Rate ....         5.8%          --           --        --          --          --
Long Term Loans ...................      $1,091       $2,849       $1,849        --      $5,789      $5,913
Weighted Average Interest Rate ....         4.6%        4.73%        8.25%       --          --          --
</TABLE>


                                       78
<PAGE>

Foreign Currency Exchange Risk

      We sell most of our products in the U.S., Canada, Europe and Israel. The
majority of our sales and expenditures are denominated in dollars. A portion of
our sales in Israel are made in NIS, and we expect to make NIS-denominated sales
in 2003 as well. Our foreign currency exposure with respect to our sales is
mitigated, and we expect it will continue to be mitigated, through salaries,
materials and support operations, in which part of these costs are denominated
in NIS. Since the beginning of 2003, the NIS has increased approximately 8.1%
against the dollar.

      Since part of our sales are quoted in NIS, and a portion of our expenses
are incurred in NIS, our results may be adversely affected by a change in the
rate of inflation in Israel if the amount of our revenues in NIS decreases and
is less than the amount of our expenses in NIS (or if such decrease is offset on
a lagging basis) or if such change in the rate of inflation is not offset, or is
offset on a lagging basis, by a corresponding devaluation of the NIS against the
dollar and other foreign currencies. A hypothetical 10 percent devaluation in
the rate of exchange of the NIS against the dollar, with all other variables
held constant, on the exposed sales would result in an approximately $280,000
decrease in our expected sales for 2003.

      We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain sales and
purchase transactions. During 2002 we did not enter into any such contracts and
as of December 31, 2002, we had no derivative financial instruments.

ITEM 12. Description of Securities Other Than Equity Securities

      Not applicable.

                                    PART II

ITEM 13. Defaults, Dividend Arrearages and Delinquencies

      Not applicable.

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

      Pursuant to the Israeli Securities Law, a company may not register its
shares on any Israeli stock exchange unless its share capital consists of only
one class of shares. Further, pursuant to the Israeli Securities Law, an Israeli
company whose shares are traded on a stock exchange outside of Israel or on
Nasdaq, may register its shares on an Israeli stock exchange under a simplified
and expedited process. In connection with effectuating the dual registration of
our ordinary shares on Nasdaq and the Tel Aviv Stock Exchange, we were required
by the Israeli Securities Law to cancel all of our issued and outstanding
deferred shares. Accordingly, following approval by our audit committee, our
board of directors, and our shareholders at our 2001 annual general meeting, we
entered into an agreement pursuant to which we purchased 186,480 deferred shares
from Mira Mag and 65,520 deferred shares from IAI for aggregate consideration
equal to the aggregate nominal value of such deferred shares. Subsequent to such
purchase, and following approval by our shareholders at our 2001 annual general
meeting, we amended our articles of association to cancel the deferred shares we
purchased from Mira Mag and IAI and deleted them from our registered and issued
and outstanding share capital.

ITEM 15. Controls and Procedures

      Within the 90 days prior to the date of the filing of this annual report,
we carried out an evaluation, under the supervision and with the participation
of our senior management, including


                                       79
<PAGE>

Chief Executive Officer Jacob Even-Ezra and Chief Financial Officer Raya Asher,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13(a)-14(c) of the Securities Exchange Act of 1934.
Disclosure controls and procedures are designed to ensure that the material
financial and non-financial information required to be disclosed in this Form
20-F filed with the SEC is recorded, processed, summarized and reported timely.
In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable, rather than absolute, assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based upon that evaluation, our management,
including the Chief Executive Officer and Chief Financial Officer, concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us required to be included in the our
periodic SEC filings.

      There have been no significant changes in our internal controls or other
factors which could significantly affect internal controls subsequent to the
date of the evaluation. Therefore, no corrective actions were taken.

ITEM 16. [Reserved]

                                    PART III

ITEM 17. Financial Statements

      We have responded to Item 18 in lieu of this item.

ITEM 18. Financial Statements

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

ITEM 19. Exhibits

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

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

      1.1*        Memorandum of Association of the Registrant

      1.2**       Articles of Association of the Registrant

      2.1***      Specimen Share Certificate for Ordinary Shares

      2.2****     The Registrant's Stock Option Plan (1993), as amended

      2.4*****    Form of Underwriters' Warrant Agreement

      2.5*****    Registration Rights Agreement, dated as of November 18, 1996,
                  by and among the Registrant, Mira Mag Inc., Israel Aircraft
                  Industries Ltd. and Jacob Even-Ezra

      10.1*****   Form of Underwriting Agreement


                                       80
<PAGE>

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

      21          List of Subsidiaries of the Registrant

      23.1        Consent of Kost Forer & Gabbay

      23.2        Consent of BDO Seidman, LLP

      99.1        Certification by Chief Executive Officer Pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002.

      99.2        Certification by Chief Financial Officer Pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002.

      99.3        Certification by Chief Executive Officer Pursuant to 18 U.S.C.
                  Section 1350, as Adopted Pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.

      99.4        Certification by Chief Financial Officer Pursuant to 18 U.S.C.
                  Section 1350, as Adopted Pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.

----------
*     Previously filed as an exhibit to our Registration Statement on Form F-1
      (No. 33-57438), filed with the Commission on January 26, 1993, as amended,
      and incorporated herein by reference.

**    Previously filed as an exhibit to our Registration Statement on Form F-1
      (No. 33-57438), filed with the Commission on January 26, 1993, as amended,
      and incorporated herein by reference and an amendment thereto previously
      filed as an exhibit to our Registration Statement on Form S-8 (No.
      333-6246), filed with the Commission on January 7, 1997 and incorporated
      herein by reference and further amendments thereto previously filed as an
      exhibit to our Annual Report on Form 20-F for the fiscal year ended
      December 31, 2000, filed with the Commission on June 29, 2001 and
      incorporated herein by reference.

***   Previously filed as an exhibit to our Registration Statement on Form 8-A,
      filed with the Commission on March 18, 1993, as amended, and incorporated
      herein by reference.

****  Previously filed as an exhibit to our Registration Statement on Form S-8
      (No. 333-6246), filed with the Commission on January 7, 1997 and
      incorporated herein by reference and further amendments thereto previously
      filed as an exhibit to our Annual Report on Form 20-F for the fiscal year
      ended December 31, 2000, filed with the Commission on June 29, 2001 and
      incorporated herein by reference.

***** Previously filed as an exhibit to our Registration Statement on Form F-2
      (No.333-5970), filed with the Commission on November 8, 1996, as amended,
      and incorporated herein by reference.


                                       81
<PAGE>

                MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2002

                                 IN U.S. DOLLARS

                                      INDEX

                                                                        Page
                                                                     -----------

Reports of Independent Auditors                                          F-2

Consolidated Balance Sheets                                           F-4 - F-5

Consolidated Statements of Income                                        F-6

Statements of Changes in Shareholders' Equity                            F-7

Consolidated Statements of Cash Flows                                 F-8 - F-9

Notes to Consolidated Financial Statements                           F-10 - F-37

                                 - - - - - - - -


                                      F-1
<PAGE>

[LOGO] ERNST & YOUNG

                         REPORT OF INDEPENDENT AUDITORS

                             To the Shareholders of

                           MAGAL SECURITY SYSTEMS LTD.

      We have audited the accompanying consolidated balance sheets of Magal
Security Systems Ltd. ("the Company") and its subsidiaries as of December 31,
2001 and 2002, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2002. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of certain wholly owned subsidiaries, which statements reflect total
revenues of 11.4% of total consolidated revenues for the year ended December 31,
2000. Those statements were audited by other auditors, whose reports have been
furnished to us, and our opinion, insofar as it relates to the amounts included
for those subsidiaries, is based solely on the reports of the other auditors.

      We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance as to 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 management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the reports of other
auditors provide a reasonable basis for our opinion.

      In our opinion, based on our audits and the reports of other auditors, the
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, 2001 and 2002, and the consolidated results of
their operations and cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.


                                                  /s/ KOST, FORER & GABBAY
Tel-Aviv, Israel                                      KOST, FORER & GABBAY
February 10, 2003
Except for Note 18 which the
Date is June 26, 2003                           A Member of Ernst & Young Global


                                      F-2
<PAGE>

Report of Independent Certified Public Accountants

The Board of Directors and Shareholders
Perimeter Products, Inc. (A Wholly Owned Subsidiary of Kobb, Inc.)

We have audited the statements of operations, shareholder's equity, and cash
flows of Perimeter Products, Inc. (A Wholly Owned Subsidiary of Kobb, Inc.) for
the year ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform our 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 by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

The value of inventory as of December 31, 2000 was overstated by $241,000 as a
result of a duplicate inventory adjustment. In addition, the balance for accrued
warranty expense as of December 31, 2000 was overstated by $35,000. If the
inventory and warranty accrual had been adjusted as of December 31, 2000, the
cost of revenue and loss before income taxes in 2000 would have increased by
$206,000, the income tax benefit in 2000 would have increased by $83,000, the
net loss in 2000 would have increased by $123,000 and retained earnings at
December 31, 2000 would have decreased by $123,000.

In our opinion, except for the effects of the prior year inventory overstatement
and the accrued warranty overstatement as described in the preceding paragraph,
the financial statements referred to above present fairly, in all material
respects, the results of operations and cash flows of Perimeter Products, Inc.
(A Wholly Owned Subsidiary of Kobb, Inc.) for the year ended December 31, 2000
in conformity with accounting principles generally accepted in the United States
of America.

/s/ BDO SEIDMAN, LLP
BDO Seidman, LLP

San Jose, California
February 2, 2001, except for the matters
     discussed in the third paragraph of our report,
     as to which the date is January 25, 2002


                                      F-3
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands

                                                                 December 31,
                                                               -----------------
                                                                2001       2002
                                                               ------     ------
      ASSETS

CURRENT ASSETS:
   Cash and cash equivalents                                    2,738      2,519
   Short-term bank deposits (Note 11c)                          8,289      3,708
   Trade receivables:
      Related parties                                              58         57
      Other (net of allowance for doubtful accounts -
         $192 in 2001 and $150 in 2002)                         6,113      9,076
      Unbilled accounts receivable                              5,586      7,691
   Other accounts receivable and prepaid expenses                 575      2,256
   Deferred income taxes                                          473        602
   Inventories (Note 3)                                         8,549      8,251
                                                               ------     ------

Total current assets                                           32,381     34,160
-----                                                          ------     ------

LONG-TERM INVESTMENTS AND TRADE RECEIVABLES:
   Long-term trade receivables (Note 4)                         2,213      1,510
   Long-term bank deposits                                      3,560      8,649
   Severance pay fund                                           1,592      1,724
                                                               ------     ------

Total long-term investments and trade receivables               7,365     11,883
-----                                                          ------     ------

PROPERTY AND EQUIPMENT, NET (Note 5)                            8,550      8,989
                                                               ------     ------

INTANGIBLE ASSETS AND OTHER (Note 6)                            1,318        853
                                                               ------     ------

GOODWILL (Note 6)                                               3,733      3,856
                                                               ------     ------

Total assets                                                   53,347     59,741
-----                                                          ======     ======

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


                                      F-4
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands

<TABLE>
<CAPTION>
                                                                                  December 31,
                                                                              --------------------
                                                                                2001         2002
                                                                              -------      -------
<S>                                                                            <C>          <C>
      LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
   Short-term bank credit (Note 7)                                              5,355        9,266
   Current maturities of long-term loans (Note 9)                                 909        1,091
   Trade payables                                                               3,394        4,192
   Other accounts payable and accrued expenses (Note 8)                         4,332        3,784
                                                                              -------      -------

Total current liabilities                                                      13,990       18,333
-----

LONG-TERM LIABILITIES:
   Long-term loans (Note 9)                                                     5,038        4,698
   Accrued severance pay                                                        1,619        1,679
                                                                              -------      -------

Total long-term liabilities:                                                    6,657        6,377
-----

COMMITMENTS AND CONTINGENT LIABILITIES (Note 10)

SHAREHOLDERS' EQUITY (Note 12):
   Share capital:
      Ordinary shares of NIS 1 par value:
         Authorized: 9,748,000 and 19,748,000 shares at December 31, 2001
            and 2002, respectively; Issued and outstanding: 7,363,866 and
            7,666,370 shares at December 31, 2001 and 2002, respectively        2,583        2,600
   Additional paid-in capital                                                  21,670       21,791
   Deferred stock compensation                                                    (20)          (3)
   Accumulated other comprehensive loss                                        (1,294)      (1,006)
   Retained earnings                                                            9,761       11,649
                                                                              -------      -------

Total shareholders' equity                                                     32,700       35,031
-----                                                                         -------      -------

Total liabilities and shareholders' equity                                     53,347       59,741
-----                                                                         =======      =======
</TABLE>

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


                                      F-5
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

                                                     Year ended December 31,
                                                  ------------------------------
                                                    2000        2001       2002
                                                  -------      ------     ------

Revenues (Note 16)                                 38,571      41,020     42,966
Cost of revenues                                   20,523      21,505     23,924
                                                  -------      ------     ------

Gross profit                                       18,048      19,515     19,042
                                                  -------      ------     ------

Operating expenses:
   Research and development, net (Note 17a)         2,975       3,054      3,128
   Sales and marketing, net                         7,129       7,933      8,642
   General and administrative                       4,661       4,949      4,938
                                                  -------      ------     ------

Total operating expenses                           14,765      15,936     16,708
                                                  -------      ------     ------

Operating income                                    3,283       3,579      2,334
Financial income (expenses), net (Note 17b)          (214)         40        199
                                                  -------      ------     ------

Income before taxes on income                       3,069       3,619      2,533
Taxes on income (Note 14)                             180         452        645
                                                  -------      ------     ------

Net income                                          2,889       3,167      1,888
                                                  =======      ======     ======

Basic net earnings per share (Note 13)               0.39        0.42       0.25
                                                  =======      ======     ======

Diluted net earnings per share (Note 13)             0.38        0.41       0.24
                                                  =======      ======     ======

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


                                      F-6
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                           AND ITS SUBSIDIARTIES

STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. dollars in thousands

<TABLE>
<CAPTION>
                                                                                Accumulated
                                                    Additional     Deferred        other                   Total          Total
                                Deferred  Ordinary    paid-in       stock      comprehensive  Retained  comprehensive  shareholders'
                                 shares    shares     capital    compensation      loss       earnings     income         equity
                                --------  --------  ----------   ------------  -------------  --------  -------------  -------------
<S>                                <C>     <C>         <C>            <C>         <C>          <C>         <C>            <C>
Balance as of January 1, 2000       72     2,472       19,313         (30)          (434)       7,481                     28,874
   Dividend paid                    --        --           --          --             --         (722)                      (722)
   Exercise of share options        --         6           48          --             --           --                         54
   Deferred stock compensation      --        --          113        (113)            --           --                         --
   Amortization of deferred
      stock compensation            --        --           --          85             --           --                         85
   Comprehensive income:
      Net income                    --        --           --          --             --        2,889      2,889           2,889
      Foreign currency
         translation
         adjustments                --        --           --          --           (281)          --       (281)           (281)
                                 -----     -----      -------        ----         ------      -------      -----         -------
Total comprehensive income                                                                                 2,608
                                                                                                           =====
Balance as of December 31, 2000     72     2,478       19,474         (58)          (715)       9,648                     30,899
   Dividend paid                    --        --           --          --             --         (942)                      (942)
   Exercise of share options        --        19          125          --             --           --                        144
   Exercise of warrants             --        11          (11)         --             --           --                         --
   Purchase of deferred shares     (72)       --           11          --             --           --                        (61)
   Deferred stock compensation      --        --           34         (34)            --           --                         --
   Amortization of deferred
      stock compensation            --        --           --          72             --           --                         72
   Stock dividend                   --        75        2,037          --             --       (2,112)                        --
   Comprehensive income:
      Net income                    --        --           --          --             --        3,167      3,167           3,167
      Foreign currency
         translation
         adjustments                --        --           --          --           (579)          --       (579)           (579)
                                 -----     -----      -------        ----         ------      -------      -----         -------
Total comprehensive income                                                                                 2,588
                                                                                                           =====
Balance as of December 31, 2001     --     2,583       21,670         (20)        (1,294)       9,761                     32,700
   Exercise of share options        --        13          125          --             --           --                        138
   Exercise of warrants             --         4           (4)         --             --           --                         --
   Amortization of deferred
      stock compensation            --        --           --          17             --           --                         17
   Comprehensive income:
      Net income                    --        --           --          --             --        1,888      1,888           1,888
      Foreign currency
         translation
         adjustments                --        --           --          --            288           --        288             288
                                 -----     -----      -------        ----         ------      -------      -----         -------
Total comprehensive income                                                                                 2,176
                                                                                                           =====
Balance as of December 31, 2002     --     2,600       21,791          (3)        (1,006)      11,649                     35,031
                                 =====     =====      =======        ====         ======      =======                    =======
</TABLE>

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


                                      F-7
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands

<TABLE>
<CAPTION>
                                                                Year ended December 31,
                                                              ----------------------------
                                                               2000       2001       2002
                                                              ------     ------     ------
<S>                                                           <C>        <C>        <C>
Cash flows from operating activities:
-------------------------------------
   Net income                                                  2,889      3,167      1,888
   Adjustments to reconcile net income to net cash
      provided by (used in) operating activities:
      Depreciation and amortization                            1,384      1,362      1,096
      Gain on sale of property and equipment                      (2)       (27)       (15)
      Accrued interest on short and long term deposits          (620)        38       (508)
      Amortization of deferred stock compensation                 85         72         17
      Decrease (increase) in trade receivables                   648       (595)    (2,861)
      Decrease in related parties receivables                     50         65          1
      Decrease (increase) in unbilled accounts receivable        883     (3,151)    (2,101)
      Decrease (increase) in other accounts receivable and
         prepaid expenses                                        399         (4)    (1,822)
      Decrease (increase) in deferred income taxes              (259)      (136)       444
      Decrease (increase) in inventories                      (2,925)       766        400
      Decrease (increase) in long-term trade receivables         115     (2,213)       705
      Increase (decrease) in other payables and
         accrued expenses                                        765        682       (532)
      Increase (decrease) in trade payables                    1,125       (392)       786
      Accrued severance pay, net                                  15         (2)       (72)
                                                              ------     ------     ------

Net cash provided by (used in) operating activities            4,552       (368)    (2,574)
                                                              ------     ------     ------

Cash flows from investing activities:
-------------------------------------
   Purchase of short-term and long-term bank deposits             --       (674)        --
   Proceeds from sale of property and equipment                   31         48         35
   Purchase of property and equipment                         (3,828)    (1,158)    (1,459)
   Purchase of know-how and patents                             (265)       (18)       (14)
                                                              ------     ------     ------

Net cash used in investing activities                         (4,062)    (1,802)    (1,438)
                                                              ------     ------     ------
</TABLE>

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


                                      F-8
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands

<TABLE>
<CAPTION>
                                                                  Year ended December 31,
                                                                ----------------------------
                                                                 2000       2001       2002
                                                                ------     ------     ------
<S>                                                              <C>        <C>        <C>
Cash flows from financing activities:
-------------------------------------
   Short-term bank credit, net                                     116      1,085      3,911
   Proceeds from long-term bank loans                            2,200      1,350         --
   Principal payment of long-term bank loans                      (584)      (180)      (158)
   Purchase of deferred shares                                      --        (61)        --
   Proceeds from exercise of employee stock options                 54        144        138
   Dividend paid                                                  (722)      (942)        --
                                                                ------     ------     ------

Net cash provided by financing activities                        1,064      1,396      3,891
                                                                ------     ------     ------

Effect of exchange rate changes on cash and cash equivalents        62        (67)       (98)
                                                                ------     ------     ------

Increase (decrease) in cash and cash equivalents                 1,616       (841)      (219)
Cash and cash equivalents at the beginning of the year           1,963      3,579      2,738
                                                                ------     ------     ------

Cash and cash equivalents at the end of the year                 3,579      2,738      2,519
                                                                ======     ======     ======

Supplemental disclosures of cash flows activities:
--------------------------------------------------
   Cash paid during the year for:
   Interest                                                        857        925        932
                                                                ======     ======     ======

   Taxes                                                           102        202      1,415
                                                                ======     ======     ======
</TABLE>

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


                                      F-9
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 1:- GENERAL

      Magal Security Systems Ltd. ("the Company") and its subsidiaries ("the
      Group"), are engaged in the development, manufacturing and marketing of
      computerized security systems used to automatically detect and deter human
      intrusion for both civilian and military markets in Israel and throughout
      the world. A majority of the Company's sales are made in U.S.A., Canada,
      Europe and Israel. During March 2001, the Company established Smart
      Interactive Systems, Inc., in order to meet the growing need for real time
      video monitoring security services.

      As for major customer data, see Note 16b.

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

      The consolidated financial statements have been prepared in accordance
      with generally accepted accounting principles in the United States ("US
      GAAP").

      a.    Use of estimates:

            The preparation of financial statements in conformity with generally
            accepted accounting principles requires management to make estimates
            and assumptions that effect the amounts reported in the financial
            statements and accompanying notes. Actual results could differ from
            those estimates.

      b.    Financial statements in U.S. dollars:

            Most of the Company and certain subsidiaries' revenues are generated
            in U.S. dollars ("dollar"). The Company's management believes that
            the dollar is the primary currency of the economic environment in
            which the Company operates. Thus, the functional and reporting
            currency of the Company and certain subsidiaries is the dollar.

            Accordingly, monetary accounts maintained in currencies other than
            the dollar are remeasured into U.S. dollars in accordance with
            Statement of the Financial Accounting Standards Board ("FASB") No.
            52 "Foreign Currency Translation". All transaction gains and losses
            from the remeasured monetary balance sheet items are reflected in
            the statement of income as financial income or expenses, as
            appropriate.

            The financial statements of certain foreign subsidiaries whose
            functional currency is not the dollar, have been translated into
            U.S. dollars. All balance sheet accounts have been translated using
            the exchange rates in effect at the balance sheet date. Statement of
            income amounts have been translated using the average exchange rate
            for the period. The resulting translation adjustments are reported
            as a component of shareholders' equity in accumulated other
            comprehensive loss.


                                      F-10
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      c.    Principles of consolidation:

            The consolidated financial statements include the accounts of the
            Company and its subsidiaries. Intercompany balances and transactions
            have been eliminated upon consolidation.

      d.    Cash equivalents:

            Cash equivalents are short-term highly liquid investments that are
            readily convertible to cash with original maturities of three months
            or less.

      e.    Short-term and long-term bank deposits:

            The Company classifies bank deposits with maturities of more than
            three months and less than one year as short-term deposits. Deposits
            with maturities of more than one year are classified as long-term
            deposits. Short-term and long-term deposits are presented at cost,
            including accrued interest.

            The deposits are in U.S. dollars and the weighted average interest
            rate in 2002 for short-term and long-term bank deposits was 4%, and
            4.1%, respectively.

      f.    Inventories:

            Inventories are stated at the lower of cost or market value.
            Inventory write-offs are provided to cover risks arising from
            slow-moving items, technological obsolesce, excess inventories,
            discontinued products, and for market prices lower than cost.

            Cost is determined as follows:

            Raw materials, parts and supplies - using the "first-in, first-out"
            method.

            Work-in-progress - represents the cost of production in progress.

            Finished products - on the basis of direct manufacturing costs with
            the addition of allocable indirect manufacturing costs.

      g.    Long-term trade receivables

            Long-term receivables from extended payment agreements are recorded
            at estimated present values determined based on current rates of
            interest and reported at the net amounts in the accompanying
            financial statements. Imputed interest is recognized, using the
            effective interest method as a component of interest income in the
            accompanying statements.


                                      F-11
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      h.    Property and equipment:

            Property and equipment are stated at cost, net of accumulated
            depreciation.

            Depreciation is computed by the straight-line method over the
            estimated useful lives of the assets as follows:

                                                             %
                                                --------------------------

            Buildings                                        4
            Machinery and equipment                10-33 (mainly at 10)
            Motor vehicles                                  15
            Promotional display                            25-50
            Office furniture and equipment                 6-33
            Leasehold improvements              over the term of the lease

      i.    Impairment of long lived assets:

            The Company's long-lived assets and certain identifiable intangibles
            are reviewed for impairment in accordance with Statement of
            Financial Accounting Standard No. 144 "Accounting for the Impairment
            or Disposal of Long- Lived Assets" ("SFAS No. 144") whenever events
            or changes in circumstances indicate that the carrying amount of an
            asset may not be recoverable. Recoverability of assets to be held
            and used is measured by a comparison of the carrying amount of an
            asset to the future undiscounted cash flows expected to be generated
            by the assets. If such assets are considered to be impaired, the
            impairment to be recognized is measured by the amount by which the
            carrying amount of the assets exceeds the fair value of the assets.

      j.    Intangible assets:

            Intangible assets subject to amortization arose from acquisitions
            prior July 1, 2001, are being amortized on a straight-line basis
            over their useful life in accordance with APB Opinion No. 17
            "Intangible Assets" ("APB No. 17"). Know-how is amortized over ten
            years, and patents are amortized over a period of ten years.

            Intangible assets acquired in a business combination for which date
            is on or after July 1, 2001, should be amortized over their useful
            life using a method of amortization that reflects the pattern in
            which the economic benefits of the intangible assets are consumed or
            otherwise used up, in accordance with Statement of Financial
            Accounting Standards No. 142 "Goodwill and Other Intangible Assets",
            ("SFAS No. 142").

      k.    Goodwill:

            Goodwill represents excess of the costs over the net assets of
            businesses acquired. Goodwill arose from acquisitions prior July 1,
            2001, was amortized until December 31, 2001, on a straight-line
            basis over a period of fifteen years. Under Statement of Financial
            Accounting Standard No. 142, "Goodwill and Other Intangible Assets"
            ("SFAS No, 142") goodwill acquired in a business combination for
            which date is on or after July 1, 2001, shall not be amortized.


                                      F-12
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            SFAS No. 142 requires goodwill to be tested for impairment on
            adoption and at least annually thereafter or between annual tests in
            certain circumstances, and written down when impaired, rather than
            being amortized as previous accounting standards required. Goodwill
            attributable to each of the reporting units is tested for impairment
            by comparing the fair value of each reporting unit with its carrying
            value. Fair value is determined using discounted cash flows, market
            multiples and market capitalization. Significant estimates used in
            the methodologies include estimates of future cash flows, future
            short-term and long-term growth rates, weighted average cost of
            capital and estimates of market multiples for each of the reportable
            units.

            SFAS No. 142 prescribes a two-phase process for impairment testing
            of goodwill. The first phase screens for impairment; while the
            second phase (if necessary) measures the impairment. The Company
            completed its first phase impairment analysis related to the
            adoption of Fas 142 during the first quarter of 2002 and its annual
            impairment test during the fourth quarter of 2002 and found no
            instances of impairment of its recorded goodwill; accordingly, the
            second testing phase was not necessary. No subsequent indicators of
            impairment have been noted by the Company.

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                                       --------------------------------
                                                         2000        2001        2002
                                                       --------    --------    --------
<S>                                                       <C>         <C>         <C>
            Net income:
               Reported net income                        2,889       3,167       1,888
               Goodwill amortization                        336         404          --
                                                       --------    --------    --------

            Adjusted net income                           3,225       3,571       1,888
                                                       ========    ========    ========

            Reported basic net earnings per share          0.39        0.42        0.25
                                                       ========    ========    ========

            Reported diluted net earnings per share        0.38        0.41        0.24
                                                       ========    ========    ========

            Goodwill amortization                          0.05        0.05          --
                                                       ========    ========    ========

            Adjusted basic net earnings per share          0.44        0.47        0.25
                                                       ========    ========    ========

            Adjusted diluted net earnings per share        0.43        0.46        0.24
                                                       ========    ========    ========
</TABLE>

      l.    Research and development costs:

            Research and development costs, net of grants received, are charged
            to the statement of income as incurred.

      m.    Warranty costs:

            The Company provides a warranty for up to 12 months, at no extra
            charge. A provision is recorded for estimated warranty costs based
            on the Company's experience.


                                      F-13
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      n.    Income taxes:

            The Company and its subsidiaries account for income taxes in
            accordance with Statement of Financial Accounting Standard No. 109
            "Accounting for Income Taxes" ("SFAS No. 109"). This Statement
            prescribes the use of the liability method whereby deferred tax
            assets and liability account balances are determined based on
            differences between financial reporting and tax bases of assets and
            liabilities and are measured using the enacted tax rates and laws
            that will be in effect when the differences are expected to reverse.
            The Company and its subsidiaries provide a valuation allowance, if
            necessary, to reduce deferred tax assets to their estimated
            realizable value.

      o.    Revenue recognition:

            The Company generates revenues mainly from long-term projects and
            also from sales of products and rendering maintenance services.

            Revenues from long-term projects are recognized in accordance with
            Statement of Position 81-1 "Accounting for Performance of
            Construction - Type and Certain Production - Type Contracts" ("SOP
            81-1"), using contract accounting on a percentage of completion
            method, based on the relationship of actual costs incurred to total
            costs estimated to be incurred over the duration of the contract and
            in accordance with the "Input Method". Provisions for estimated
            losses on uncompleted contracts are made in the period in which such
            losses are first determined, in the amount of the estimated loss on
            the entire contract. As of December 31, 2002, no such estimated
            losses were identified.

            Estimated gross profit or loss from long-term contracts may change
            due to changes in estimates resulting from differences between
            actual performance and original forecasts. Such changes in estimated
            gross profit are recorded in results of income when they are
            reasonably determinable by management, on a cumulative catch-up
            basis.

            According to ("SOP 81-1"), costs that are incurred for a specific
            anticipated contract are being deferred, subject to evaluation of
            their probable recoverability, and only if the costs can be directly
            associated with a specific anticipated contract.

            Revenues from product sales are recognized in accordance with Staff
            Accounting Bulletin No. 101 "Revenue Recognition in Financial
            Statements", ("SAB No. 101"), when delivery has occurred, persuasive
            evidence of an agreement exists, the vendor's fee is fixed or
            determinable, no further obligation exists and collectability is
            probable.

            Deferred revenue includes unearned amounts received under
            maintenance contracts but not yet recognized as revenues.


                                      F-14
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      p.    Advertising expenses:

            Advertising expenses are charged to the statement of income as
            incurred. Advertising expenses for the years ended 2000, 2001 and
            2002, were $354, $349 and $372, respectively.

      q.    Concentrations of credit risk:

            Financial instruments that potentially subject the Company and its
            subsidiaries to concentrations of credit risk consist principally of
            cash and cash equivalents, short and long-term bank deposits, trade
            receivables and long-term trade receivables.

            The Company's cash and cash equivalents, short-term and long-term
            bank deposits are invested in major Israeli and U.S. banks. Such
            deposits in U.S. banks may be in excess of insured limits and are
            not insured in other jurisdictions. Management believes that the
            financial institutions that hold the Company's investments are
            financially sound and, accordingly, minimal credit risk exists with
            respect to these investments.

            The trade receivables of the Company and its subsidiaries are
            derived from sales to large and solid organizations located mainly
            in Israel, the United States, Canada and Europe. The Company
            performs ongoing credit evaluations of its customers and to date has
            not experienced any material losses. An allowance for doubtful
            accounts is determined with respect to those amounts that the
            Company has determined to be doubtful of collection.

            The Company has no off balance sheet concentration of credit risk
            such as foreign exchange contracts option contracts or other foreign
            hedging arrangements.

      r.    Stock-based compensation:

            The Company has elected to follow Accounting Principles Board
            Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25")
            and Interpretation No. 44 "Accounting for Certain Transactions
            Involving Stock Compensation" ("FIN 44") in accounting for its
            employee stock option plans. Under APB 25, when the exercise price
            of the Company's share options is less than the market price of the
            underlying shares on the date of grant, compensation expense is
            recognized.

            Pro-forma information regarding net income and net earnings per
            share is required by SFAS No. 123, and has been determined as if the
            Company had accounted for its employee stock options under the fair
            value method of that Statement. The fair value for these options was
            estimated at the grant date using a Black and Scholes option pricing
            model with the following weighted-average assumptions for 2000 and
            2001: risk-free interest rates of 5% and 3%, respectively, dividend
            yields of 3% for each year, a volatility factor of the expected
            market price of the Company's Ordinary shares of 0.556 and 0.628,
            respectively, and a weighted average life of the option of two
            years.


                                      F-15
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            For purposes of pro forma disclosures, the estimated fair value of
            the options is amortized to expense over the options' vesting
            period.

            Pro-forma net information under FASB-123:

                                                        Year ended December 31,
                                                        -----------------------
                                                         2000     2001     2002
                                                        -----    -----    -----

            Net income as reported                      2,889    3,167    1,888
                                                        =====    =====    =====

            Add: stock based compensation as
               reported                                    85       72       17
                                                        =====    =====    =====

            Deduction: total stock-based
               compensation determined under fair
               value based method for all awards          218      238      246
                                                        =====    =====    =====

            Pro-forma net income                        2,756    3,001    1,659
                                                        =====    =====    =====

            Pro-forma basic net earnings per share       0.37     0.40     0.22
                                                        =====    =====    =====

            Pro-forma diluted net earnings per share     0.36     0.39     0.22
                                                        =====    =====    =====

      s.    Royalty-bearing grants:

            Royalty-bearing grants from the Government of Israel for funding
            research and development projects are recognized at the time the
            Company is entitled to such grants on the basis of the related costs
            incurred and recorded as a deduction of research and development
            costs. Research and development grants recognized amounted to $25,
            $0 and $318 in 2000, 2001 and 2002, respectively.

            The Company also received royalty-bearing grants from the Fund for
            Encouragement of Marketing Activity. These grants are recognized at
            the time the Company is entitled to such grants on the basis of the
            costs incurred and included as a deduction of sales and marketing
            expenses.


                                      F-16
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      t.    Severance pay:

            The Company's liability for severance pay is calculated pursuant to
            Israeli severance pay law based on the most recent salary of the
            employees multiplied by the number of years of employment, as of the
            balance sheet date. Employees are entitled to one month's salary for
            each year of employment or a portion thereof. The Company's
            liability for its employees in Israel is fully provided by monthly
            deposits with insurance policies and by an accrual. The value of
            these policies is recorded as an asset in the Company's balance
            sheet.

            The deposited funds may be withdrawn only upon the fulfillment of
            the obligation pursuant to Israeli severance pay law or labor
            agreements. The value of the deposited funds is based on the cash
            surrendered value of these policies, and includes immaterial
            profits.

            Severance expenses for the years ended December 31, 2000, 2001 and
            2002, amounted to approximately $225, $241 and $60, respectively.

      u.    Fair value of financial instruments:

            The following methods and assumptions were used by the Company and
            its subsidiaries in estimating their fair value disclosures for
            financial instruments:

            The carrying amounts of cash and cash equivalents, short-term bank
            deposits, trade receivables and other accounts receivable,
            short-term bank credit, trade payables and other payables
            approximate their fair value due to the short-term maturity of such
            instruments.

            The carrying amount of the Company's long-term trade receivables and
            long-term deposits approximate their fair value. The fair value was
            estimated using discounted cash flow analyses, based on the
            Company's investment rates for similar type of investment
            arrangements.

            The fair value of the Company's long-term borrowing arrangements was
            estimated using discounted cash flow analyses. Based on the
            Company's incremental borrowing rate for similar types of borrowing
            arrangements.

      v.    Basic and diluted earnings per share:

            Basic earnings per share is computed based on the weighted average
            number of Ordinary Shares outstanding during each year. Diluted
            earnings per share is computed based on the weighted average number
            of Ordinary shares outstanding during each year, plus dilutive
            potential Ordinary shares considered outstanding during the year, in
            accordance with FASB Statement of Financial Accounting Standard No.
            128, "Earnings Per Share" ("SFAS No. 128").


                                      F-17
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      w.    Reclassification:

            Certain amounts from prior years have been reclassified to conform
            to the current year's presentation. The reclassification had no
            effect on previously reported net loss, shareholders' equity or cash
            flows.

      x.    Impact of recently issued accounting standards:

            In June 2002, the FASB issues SFAS No. 146, "Accounting for Costs
            Associated with Exit or Disposal Activities," which addresses
            significant issue regarding the recognition, measurement, and
            reporting of costs associated with exit and disposal activities,
            including restructuring activities. SFAS No. 146 requires that costs
            associated with exit or disposal activities be recognized when they
            are incurred rather than at the date of a commitment to an exit or
            disposal plan. SFAS No. 146 is effective for all exit or disposal
            activities initiated after December 31, 2002. The Company does not
            expect the adoption of SFAS No. 146 to have a material impact on our
            results of operations or financial position.

            In November 2002, the FASB issued FASB Interpretation No. 45,
            "Guarantor's Accounting and Disclosure Requirements for Guarantees,
            Including Indirect Guarantees of Indebtedness of Others, an
            interpretation of FASB Statements No. 5, 57, and 107 and Rescission
            of FASB Interpretation No. 34" ("FIN No. 45"). FIN No. 45 elaborates
            on the disclosures to be made by a guarantor in its interim and
            annual financial statements about its obligations under certain
            guarantees that it has issued. It also clarifies that a guarantor is
            required to recognize, at the inception of a guarantee, a liability
            for the fair value of the obligation undertaken in issuing the
            guarantee. FIN No. 45 does not prescribe a specific approach for
            subsequently measuring the guarantor's recognized liability over the
            term of the related guarantee. It also incorporates, without change,
            the guidance in FASB Interpretation No. 34, "Disclosure of Indirect
            Guarantees of Indebtedness of Others," which is being superseded.
            The disclosure provisions of FIN No. 45 are effective for financial
            statements of interim or annual periods that end after December 15,
            2002 and the provisions for initial recognition and measurement are
            effective on a prospective basis for guarantees that are issued or
            modified after December 31, 2002, irrespective of a guarantor's
            year-end. The Company does not expect the adoption of FIN No. 45 to
            have a material impact on its results of operations or financial
            position.

            In November 2002, the Emerging Issues Task Force (EITF) of the FASB
            reached a consensus on EITF No. 00-21, "Accounting for Revenue
            Arrangements with Multiple Element Deliverables." The issue
            addresses how to account for arrangements that may involve multiple
            revenue-generating activities, i.e., the delivery or performance of
            multiple products, services, and/or rights to use assets. In
            applying this guidance, separate contracts with the same party,
            entered into at or near the same time, will be presumed to be a
            package, and the consideration will be measured and allocated to the
            separate units based on their relative fair values. This consensus
            guidance will be applicable to agreements entered into in quarters
            beginning after June 15, 2003. The Company will adopt this new
            accounting effective July 1, 2003. The Company is currently
            evaluating the impact of this change.


                                      F-18
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
            Consolidation of Variable Interest Entities. FIN 46 clarifies the
            application of Accounting Research Bulletin 51, Consolidated
            Financial Statements, for certain entities that do not have
            sufficient equity at risk for the entity to finance its activities
            without additional subordinated financial support from other parties
            or in which equity investors do not have the characteristics of a
            controlling financial interest ("variable interest entities").
            Variable interest entities within the scope of FIN 46 will be
            required to be consolidated by their primary beneficiary. The
            primary beneficiary of a variable interest entity is determined to
            be the party that absorbs a majority of the entity's expected
            losses, receives a majority of its expected returns, or both. FIN 46
            applies immediately to variable interest entities created after
            January 31, 2003, and to variable interest entities in which an
            enterprise obtains an interest after that date. It applies in the
            first fiscal year or interim period beginning after June 15, 2003,
            to variable interest entities in which an enterprise holds a
            variable interest that it acquired before February 1, 2003. The
            Company is in the process of determining what impact, if any, the
            adoption of the provisions of FIN 46 will have upon its financial
            condition or results of operations. Certain transitional disclosures
            required by FIN 46 in all financial statements initially issued
            after January 31, 2003, have been included in the accompanying
            financial statements.

            In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
            Financial Instruments with Characteristics of both Liabilities and
            Equity. "This Statement establishes standards for how an issuer
            classifies and measures in its statement of financial position
            certain financial instruments with characteristics of both
            liabilities and equity. It requires that an issuer classify a
            financial instrument that is within its scope as a liability (or an
            asset in some circumstances) because that financial instrument
            embodies an obligation of the issuer. This Statement is effective
            for financial instruments entered into or modified after May 31,
            2003, and otherwise is effective at the beginning of the first
            interim period beginning after June 15, 2003, except for mandatory
            redeemable financial instruments of nonpublic entities. The Company
            does not expect that the adoption of this standard will have a
            material effect on its financial position or results of operations.

NOTE 3:- INVENTORIES

                                                          December 31,
                                                     ---------------------
                                                      2001            2002
                                                     -----           -----

      Raw materials                                  5,269           4,702
      Work in progress                               1,255           1,242
      Finished products                              2,025           2,307
                                                     -----           -----

                                                     8,549           8,251
                                                     =====           =====


                                      F-19
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 4:- LONG-TERM TRADE RECEIVABLES

      The Company signed an agreement with a customer, according to which the
      payments schedule is for a period ending February, 2005.

      As of December 2002, the aggregate annual maturities of the long-term
      trade receivables are as follows:

      2003                                              1,284
      2004                                              1,284
      2005                                                226
                                                        -----

                                                        2,794
      Less - current maturities                         1,284
                                                        -----

                                                        1,510
                                                        =====

NOTE 5:- PROPERTY AND EQUIPMENT

      a.    Comprised as follows:

                                                      December 31,
                                                    ----------------
                                                     2001      2002
                                                    ------    ------
            Cost:
               Land and buildings                    7,717     7,846
               Machinery and equipment               2,782     3,406
               Motor vehicles                        1,288     1,333
               Promotional display                   2,624     2,895
               Office furniture and equipment        1,952     2,186
               Leasehold improvements                   24        23
                                                    ------    ------

                                                    16,387    17,689
                                                    ------    ------
            Accumulated depreciation:
               Buildings                             1,500     1,744
               Machinery and equipment               2,149     2,416
               Motor vehicles                          618       608
               Promotional display                   2,011     2,229
               Office furniture and equipment        1,537     1,682
               Leasehold improvements                   22        21
                                                    ------    ------

                                                     7,837     8,700
                                                    ------    ------

            Depreciated cost                         8,550     8,989
                                                    ======    ======

      b.    Depreciation expenses amounted to $743, $858 and $1,014 for the
            years ended December 31, 2000, 2001 and 2002, respectively.

      c.    As for charges, see Note 11.


                                      F-20
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 6:- GOODWILL, INTANGIBLE ASSETS AND OTHER

      a.    Intangible assets:

                                                      December 31,
                                                    ----------------
                                                     2001       2002
                                                    -----      -----
            Original amounts:
               Know-how                             1,502      1,502
               Patents                              1,884      1,913
                                                    -----      -----

                                                    3,386      3,415
                                                    -----      -----
            Accumulated amortization:
               Know-how                             1,212      1,267
               Patents                              1,765      1,806
                                                    -----      -----

                                                    2,977      3,073
                                                    -----      -----

            Amortized cost                            409        342
                                                    -----      -----

      b.    Other:

            Deferred income taxes                     909        511
                                                    -----      -----

                                                    1,318        853
                                                    =====      =====

            Amortization expenses amounted to $305, $100 and $82 for the years
            2000, 2001 and 2002, respectively.

      c.    Goodwill:

                                                      December 31,
                                                    ----------------
                                                     2001       2002
                                                    -----      -----

            Original amounts                        5,257      5,443
            Accumulated amortization                1,524      1,587
                                                    -----      -----

                                                    3,733      3,856
                                                    =====      =====

            Amortization expenses amounted to $336, $404 and $0 for the years
            2000, 2001 and 2002, respectively.


                                      F-21
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 7:- SHORT-TERM BANK CREDIT

      a.    As of December 31, 2002, the Company and its subsidiaries have
            authorized credit lines totaling $24,000, and unused credit lines in
            the amount of $3,975.

            The Company has undertaken to maintain the following financial
            ratios and terms in respect of its short-term and long-term bank
            credit and loans:

            1.    A ratio of at least 40% of shareholders' equity out of the
                  total balance sheet.

            2.    Minimal annual net income in the amount of $ 1,000.

            3.    That the same shareholders maintain the core of control in the
                  Company.

            As of December 31, 2002, the Company was in compliance with these
            ratios.

<TABLE>
<CAPTION>
                                                        Interest rate                      December 31,
                                Linkage          ---------------------------           -----------------
                                 terms             2001               2002              2001        2002
                              ----------         ---------------------------           -----       -----
                                                              %
                                                 ---------------------------
<S>                           <C>                <C>               <C>                 <C>         <C>
            Bank                U.S. $             3.10               2.28             1,000         500
            Bank                U.S. $           2.62-2.87         2.87-3.25           1,950       4,600
            Bank              Canadian $         Prime+0.5         Prime+0.5              31         843
            Bank                 NIS             Prime+0.5          9.9-10.4           2,374       3,323
                                                                                       -----       -----

                                                                                       5,355       9,266
                                                                                       =====       =====
</TABLE>

      b.    As for charges, see note 11.

NOTE 8:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

                                                           December 31,
                                                        ------------------
                                                         2001         2002
                                                        -----        -----

      Employees and payroll accruals                    1,488        1,414
      Accrued expenses                                  1,901        1,922
      Income tax payable                                  555          124
      Government authorities                               91           --
      Other                                               297          324
                                                        -----        -----

                                                        4,332        3,784
                                                        =====        =====


                                      F-22
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 9:- LONG-TERM LOANS

<TABLE>
<CAPTION>
                                                               Interest rate                      December 31,
                                       Linkage          ---------------------------           -----------------
                                        terms             2001               2002              2001        2002
                                     ----------         ---------------------------           -----       -----
                                                                     %
                                                        ---------------------------
<S>                                  <C>                <C>               <C>                 <C>         <C>
      Bank (1)                         U.S. $              7.87              4.60             2,500       2,500
      Bank (2)                         U.S. $           LIBOR+0.5          LIBOR+0.5            250         250
      Bank (3)                         U.S. $              3.68              2.87               500         500
      Bank (4)                         U.S. $              5.66              5.66               500         500
                                                                                              -----       -----

                                                                                              3,750       3,750

      Mortgage payable (5)           Canadian $         LIBOR+0.75        LIBOR+0.75             75          --

      Mortgage payable (6)             U.S. $              8.25              8.25             2,122       2,039
                                                                                              -----       -----

                                                                                              5,947       5,789
      Less - current maturities                                                                 909       1,091
                                                                                              -----       -----

                                                                                              5,038       4,698
                                                                                              =====       =====
</TABLE>

      As for financial ratios and terms in respect of long-term loans, see also
      Note 7a.

      As for charges, see Note 11.

      As of December 2002, the aggregate annual maturities of the long-term
      loans are as follows:

      2003                                                                1,091
      2004                                                                2,849
      2005                                                                1,849
                                                                          -----
                                                                          5,789
                                                                          =====

      (1)   Interest on the outstanding balance is due monthly. The note is due
            in one installment on April 1, 2004, extended from April 1, 2002.

      (2)   Interest on the outstanding balance is due each quarter. The note is
            due in one installment on April 2, 2004, extended from April 2,
            2002.

      (3)   The note is due on April 2, 2003.

      (4)   The note is due on April 2, 2003.

      (5)   The mortgage is payable in equal quarterly installments of $25.2
            thousand each, plus interest.

      (6)   The note is due in 18 quarterly installments of $64.7 thousand each,
            commencing from February 28, 2001 and thereafter, until a final
            payment of $1,806.6 on November 30, 2005.


                                      F-23
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES

      a.    Royalty commitments to the Chief Scientist:

            The Company participated in programs sponsored by the Israeli
            Government for the support of research and development activities.
            Through the year 2002, the Company had obtained grants from Office
            of the Chief Scientist of the Israeli Ministry of Industry and Trade
            ("the OCS") of $318 for certain research and development projects of
            the Company. The Company is obligated to pay royalties to the OCS,
            amounting to 3%-4% of the sales of the products and other related
            revenues generated from such projects, up to 100%-150% of the grants
            received, linked to the U.S. dollar and grants received after
            January 1, 1999 will also bear interest at the rate of LIBOR. The
            obligation to pay these royalties is contingent on actual sales of
            the products and in the absence of such sales no payment is
            required.

            Royalties paid amounted to $86, $0 and $131 for the years ended
            December 31, 2000, 2001 and 2002, respectively.

            As of December 31, 2002, the Company had remaining contingent
            obligations to pay royalties in the amount of approximately $1,538
            upon the successful sale of products developed using such research
            and development programs sponsored by the Chief Scientist.

      b.    The Israeli Government, through the Fund for the Encouragement of
            Marketing Activities, awarded the Company grants for participation
            in expenses for overseas marketing. The Company is committed to pay
            royalties at the rate of 3% of the increase in export sales, up to
            the amount of the grants received.

            Grants received for the years up to and including 2002, amounted to
            $310 and royalties paid during 2001 and 2002, amounted to $104 and
            $53, respectively. As of December 31, 2002, the aggregate contingent
            obligation amounted to $153.

      c.    Lease commitments:

            The subsidiaries rent their facilities under various operating lease
            agreements, which expire on various dates, the latest of which is in
            2006.

            Future minimum lease payments under non-cancelable lease agreements
            as of December 31, are as follows:

            2003                           $117
            2004                           $105
            2005                           $ 69
            2006                           $ 30
                                           ----

                                           $321
                                           ====

            Rental expenses amounted to $196, $122 and $183 in 2000, 2001 and
            2002, respectively.


                                      F-24
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

      d.    Guarantees:

            1.    As of December 31, 2002, the Company and its subsidiaries
                  obtained bank performance guarantees and advance payment
                  guarantees from several banks mainly in Israel in the amount
                  of $4,616.

            2.    As of December 31, 2002, the Company obtained bank guarantees
                  in the amount of $262, in order to secure a credit facility of
                  a subsidiary.

            3.    As of December 31, 2002, the Company obtained bank guarantees
                  in an amount of $2,039 in order to secure mortgage payable by
                  a subsidiary.

            4.    As of December 31, 2002, the Company and its subsidiaries
                  issued a letter of credit in the amount of $88, as per the
                  suppliers' demand.

      e.    Legal proceedings:

            In June 2000, Rapiscan Security Products Inc. ("Rapiscan") filed a
            lawsuit against the Company claiming sums allegedly due to Rapiscan
            in the context of an agreement between Rapiscan and the Company
            amounting to $1.6 thousand. The Company filed a counter-claim for
            the balance of approximately $1.35 thousand. The Company recorded an
            accrual regarding this lawsuit of approximately $1.2 thousand, which
            is an appropriate liability as estimated by the Company's management
            and its legal counsel.

            In addition, during 2002, several claims were filed against the
            Company by competitors in the sector concerning the Company's
            winning a specific tender. The main claim was that the conditions
            for the tender gave an advantage to the Company. The Company filed a
            counter claim alleging that the competitors delayed in filing their
            claim. The request to cancel the tender is still being deliberated
            by the court. According to the Company's legal counsel, the Company
            has good defenses against the aforementioned claims, therefore, no
            allowance was recorded in the financial statements.

NOTE 11:- CHARGES

      As collateral for all of the Company and its subsidiaries' liabilities to
      banks:

      a.    A fixed charge has been placed on the Company's property.

      b.    The Company agreed not to pledge any of its assets without the
            consent of several banks.

      c.    A fixed charge in the amount of $3,250 has been placed on the
            Company's bank deposits.

      d.    The Company's subsidiary has two notes payable in the aggregate
            amount of $1,000 due on April 2, 2003, collateralized by
            substantially all of the subsidiary's assets, and a $2,039 mortgage
            note payable, collateralized by a first mortgage on the land and
            building.


                                      F-25
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 12:- SHAREHOLDERS' EQUITY

      a.    Pertinent rights and privileges conferred by Ordinary shares:

            The Ordinary shares of the Company are traded on Nasdaq National
            Market and in Israel, on the Tel-Aviv Stock Exchange ("TASE"). The
            Ordinary shares confer upon their holders the right to receive
            notice, to participate and vote in the general meetings of the
            Company and the right to receive dividends, if declared.

      b.    Deferred shares:

            Prior to the Company's Initial Public Offering in 1993, the
            Company's existing shareholders agreed to put into escrow 252,000
            (after taking into account the effect of the stock dividend) of the
            Ordinary shares held by them and to convert all, or a portion, of
            such escrowed shares into "Deferred shares", in the event that
            specified audited after tax net income levels were not achieved by
            the Company in each of the three fiscal years in the period ended
            December 31, 1995.

            Since the Company did not achieve such levels of net income, 252,000
            Ordinary shares have been converted into Deferred shares of NIS 1
            par value each. The deferred shares entitle their holders, upon the
            liquidation of the Company, to the par value of these shares, but
            confer no other rights.

            During 2001, the Company registered its shares in the Tel-Aviv Stock
            Exchange. Pursuant to the Israeli Securities Law, the Company was
            required to cancel all its Deferred shares. The annual general
            meeting that was held on May 16, 2001 approved the purchase of
            252,000 Deferred shares by the Company at their nominal value and to
            remove them from the Company's registered, issued and outstanding
            share capital.

      c.    Stock Option Plan:

            On February 25, 1993, the Company's Board of Directors authorized a
            stock option plan (the "plan"), under which options may be granted
            to employees, directors, officers and consultants of the Company or
            its subsidiaries.

            According to the plan, the exercise price shall be at least 75% of
            the average of the closing prices of the shares of the Company on
            the Nasdaq National Market during the 90 days period preceding such
            grant. The plan was supposed to be terminated on February 25, 2001.

            On May 31, 2000, the Company's Board of Directors approved an
            extension period to the plan in which options may be granted to
            employees until February 2005. Stock options that have not been
            exercised will expire, in any case, after five years from the date
            of grant. All the options have a vesting period of two years. Any
            options that are cancelled or forfeited before expiration become
            available for future grant.

            During 2000, the Company's board of directors and the general
            meeting of shareholders, also approved an increase in the number of
            options that may be granted to employees by 250,000 options, and
            during 2002, was increased by another 500,000 options.


                                      F-26
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 12:- SHAREHOLDERS' EQUITY (Cont.)

            Under the plan, stock options will be periodically granted in
            accordance with the decision of the Board of Directors of the
            Company (or a committee appointed by them). The Board of Directors
            has the authority to determine the amount of options, if any, which
            will be granted to each of the aforementioned, the dates of the
            grant of such options, the date of their exercise as well as their
            rate of conversion into shares in respect of each stock option.

            A summary of the Company's stock options activities in 2000, 2001
            and 2002, is as follows:

<TABLE>
<CAPTION>
                                                                                       Options outstanding
                                                                       -----------------------------------------------------
                                                                                                      Weighted     Market
                                                       Available         Number         Range of      average     price at
                                                          for          of options       exercise      exercise   the date of
                                                         grant         outstanding       price         price        grant
                                                       ---------       -----------      --------      --------   -----------
<S>                                                    <C>               <C>           <C>              <C>         <C>
            Balance at January 1, 2000                  160,200          191,325         2-2.36            2           --
            Options granted                             (94,000)          94,000          2.36          2.36        3.563
            Options forfeited                                --             (500)          --             --           --
            Options available for grant                 250,000               --           --             --           --
            Options exercised                                --          (27,525)           2              2           --
                                                       --------         --------       ---------        ----        -----

            Balance at December 31, 2000                316,200          257,300         2-2.36         2.09           --
            Options granted                            (234,400)         234,400       2.43-5.62        5.27         5.42
            Options exercised                                --          (79,300)        1.61-2         1.80           --
                                                       --------         --------       ---------        ----        -----

            Balance at December 31, 2001                 81,800          412,400       1.61-5.62        3.93           --
            Options available for grant                 500,000               --           --             --           --
            Options forfeited                             1,648           (1,648)          --             --           --
            Options granted upon stock dividend           2,454           11,232           --             --           --
            Options exercised                                --          (63,750)        2-2.36         2.17           --
                                                       --------         --------       ---------        ----        -----

            Balance at December 31, 2002                585,902          358,234       1.61-5.62        4.23           --
                                                       ========         ========       =========        ====        =====
</TABLE>

            The weighted average fair values of options granted during the years
            ended December 31, 2000, 2001 and 2002, were:

<TABLE>
<CAPTION>
                                                      For exercise price on the grant date that:
                                           --------------------------------------------------------------
                                                Equals market price            Less than market price
                                           -----------------------------    -----------------------------
                                              Year ended December 31,          Year ended December 31,
                                           -----------------------------    -----------------------------
                                            2000       2001       2002       2000       2001       2002
                                           -------    -------    -------    -------    -------    -------
<S>                                         <C>        <C>        <C>        <C>        <C>        <C>
            Weighted average exercise
               prices                           --       5.62         --       2.36       2.69         --
                                           =======    =======    =======    =======    =======    =======

            Weighted average fair value
               on grant date                    --       2.04         --       2.36       1.91         --
                                           =======    =======    =======    =======    =======    =======
</TABLE>


                                      F-27
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 12:- SHAREHOLDERS' EQUITY (Cont.)

            The options outstanding as of December 31, 2002 have been separated
            into ranges of exercise price as follows:

            Options                                                 Options
          outstanding                                            exercisable as
             as of                           Remaining                 of
            December       Exercise         contractual           December 31,
            31, 2002        price              life                   2002
          -----------      --------         -----------          --------------
                                            (in months)

             29,870             2                4                   29,870
             20,600          1.61               12                   20,600
              6,180          2.29               18                    6,180
             61,800          2.36               25                   61,800
             12,360          2.43               37                       --
             16,480          2.89               40                       --
            210,944          5.62               43                       --
            -------          ----                                    -------

            358,234          4.23                                    118,450
            =======          ====                                    =======

            157,300, 84,000 and 118,450 options were exercisable on December 31,
            2000, 2001 and 2002, respectively, with a weighted average exercise
            price of $1.85, $1.93 and $2.14.

            The total employee stock compensation expenses recorded in 2000,
            2001 and 2002, were $85, $72 and $17, respectively, and were
            amortized based on the vesting period.

      d.    Dividends:

            Dividends, if any, will be declared and paid in NIS. Dividends paid
            to shareholders outside Israel will be converted into U.S. dollars
            on the basis of the exchange rate prevailing at the date of payment.
            The Company has determined that it will not distribute dividends out
            of tax-exempt profits.

      e.    Warrants to underwriters:

            In connection with the 1997 Offering, the Company issued to the
            underwriters, 200,000 warrants to purchase from the Company 200,000
            Ordinary shares. The warrants were initially exercisable at an
            exercise price of 120% of the 1997 Offering price per share ($5.50)
            for a period of four years, commencing one year from the date of the
            1997 Offering. As of December 31, 2002, all 200,000 warrants were
            exercised on a net cash basis and 60,703 Ordinary shares of NIS 1
            par value were issued.


                                      F-28
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 12:- SHAREHOLDERS' EQUITY (Cont.)

      f.    In May 2002, the Company's Board of Directors decided on a
            distribution of a 3% stock dividend. All basic net earnings per
            share data and diluted net earnings per share data have been
            retroactively adjusted to reflect the stock dividend.

      g.    In May 2002, the Company's Board of Directors decided on an increase
            of the authorized Ordinary share capital to 19,748,000 shares of NIS
            1 par value.

NOTE 13:- NET EARNINGS PER SHARE

      The following table sets forth the computation of basic and diluted net
      earnings per share:

<TABLE>
<CAPTION>
                                                                Year ended December 31,
                                                          -----------------------------------
                                                             2000         2001         2002
                                                          ---------    ---------    ---------
<S>                                                       <C>          <C>          <C>
      Numerator:
      Net income                                              2,889        3,167        1,888
                                                          =========    =========    =========

      Denominator:

      Denominator for basic earnings per share -
         weighted-average number of shares outstanding    7,439,622    7,512,148    7,637,356
      Effect of diluted securities:
      Employee stock options and warrants to
         underwriters                                        84,905      181,880      196,759
                                                          ---------    ---------    ---------

      Denominator for diluted net earnings per share-
         adjusted weighted average shares and
         Assumed conversions                              7,524,527    7,694,028    7,834,115
                                                          =========    =========    =========

      Basic net earnings per share                             0.39         0.42         0.25
                                                          =========    =========    =========

      Diluted net earnings per share                           0.38         0.41         0.24
                                                          =========    =========    =========
</TABLE>


                                      F-29
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 14:- TAXES ON INCOME

      a.    Tax benefits in Israel under the Law for the Encouragement of
            Capital Investments, 1959, ("the law"):

            The Company has been granted the status of an "Approved Enterprise"
            under the law. Currently, there are three expansion programs under
            which the Company is entitled to tax benefits:

            1.    In 1992, a program of the Company was granted the status of an
                  "Approved Enterprise". The Company has elected to enjoy
                  "alternative benefits" - waiver of grants in return for tax
                  exemption - and, accordingly, the Company's income from the
                  second program is tax-exempt for a period of four years, and
                  was subject to a reduced tax rate of 15%-25% for a period
                  ranging between three to six years (depending on the
                  percentage of foreign ownership of the Company).

                  The period of benefits under this program began in 1994 and
                  will terminate in 2003.

                  The Company received final status of "Approved Enterprise" for
                  this expansion.

            2.    On March 18, 1997, a program of the Company was granted the
                  status of an "Approved Enterprise". The Company elected to
                  enjoy "alternative benefits" - waiver of grants in return for
                  tax exemption and accordingly, the Company's income from this
                  program is tax-exempt for a period of four years, and was
                  subject to a reduced tax rate of 15%-25% for a period ranging
                  between three to six years (depending on the percentage of
                  foreign ownership of the Company).

                  The Company had completed its investment program and,
                  accordingly, the period of benefits under this program began
                  in 1998 and will terminate in 2007.

            3.    On August 13, 2001, a program of the Company was granted the
                  status of an "Approved Enterprise". The Company elected to
                  enjoy "alternative benefits" - waiver of grants in return for
                  tax exemption - and, accordingly, the Company's income from
                  this program is tax-exempt for a period of two years, subject
                  to a reduced tax rate of 15%-25% for a period of five to eight
                  years (depending upon the percentage of foreign ownership of
                  the Company). The benefit period for this program has not yet
                  begun.


                                      F-30
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 14:- TAXES ON INCOME (Cont.)

            The entitlement to the above benefits is conditional upon the
            Company fulfilling the conditions stipulated by the above law,
            regulations published thereunder and the instruments of approval for
            the specific investments in "approved enterprises". In the event of
            failure to comply with these conditions, the benefits may be
            canceled and the Company may be required to refund the amount of the
            benefits, in whole or in part, including interest.

            The period of tax benefits detailed above is subject to limits of
            the earlier of 12 years from the commencement of production or 14
            years from receiving the approval.

            Income from sources other than "Approved Enterprise", during the
            benefit period will be subject to tax at regular rate of 36%.

            By virtue of this law, the Company is entitled to claim accelerated
            depreciation on equipment used by the "Approved Enterprise" during
            five tax years.

            Since the Company is operating under more than one approval and
            since part of its taxable income is not entitled to tax benefits
            under the aforementioned law and is taxed at regular rates
            (currently 36%), its effective tax rate is the result of a weighted
            combination of the various applicable rates and tax-exemptions. The
            computation is made for income derived from each program on the
            basis of formulas determined in the law and in the approvals.

            The tax-exempt income attributable to the "Approved Enterprises" can
            be distributed to shareholders without subjecting the Company to
            taxes only upon the complete liquidation of the Company. If the
            retained tax-exempt income is distributed in a manner other than in
            the complete liquidation of the Company, it would be taxed at the
            corporate tax rate applicable to such profits as if the Company had
            not chosen the alternative tax benefits (currently - 15%), and an
            income tax liability would be incurred of approximately $0.7
            thousand.

      b.    Measurement of taxable income under the Income Tax (Inflationary
            Adjustments) Law, 1985:

            Results for tax purposes in Israel, are measured and reflected in
            real terms in accordance with the change in the Israeli Consumer
            Price index ("CPI"). As explained in Note 2b the consolidated
            financial statements are presented in U.S. dollars. The differences
            between the change in the Israeli CPI and in the NIS/U.S. dollar
            exchange rate causes a difference between taxable income or loss and
            the income or loss before taxes reflected in the consolidated
            financial statements. In accordance with paragraph 9(f) of SFAS No.
            109, the Company has not provided deferred income taxes on this
            difference between the reporting currency and the tax bases of
            assets and liabilities.

      c.    Tax benefits (in Israel) under the Law for the Encouragement of
            Industry (Taxes), 1969:

            The Company is an "industrial company" as defined by this law and,
            as such, is entitled to certain tax benefits including accelerated
            depreciation, deduction of the purchase price of patents and
            know-how and deduction of public offering expenses.


                                      F-31
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 14:- TAXES ON INCOME (Cont.)

      d.    Israeli tax reform:

            On January 1, 2003, the Law for Amendment of the Income Tax
            Ordinance (Amendment No. 132) 5762-2002, known as the tax reform,
            became effective. The tax reform changed the Israeli tax system from
            a territorial tax method into a personal tax method on a global
            basis.

      e.    A reconciliation between the theoretical tax expense, assuming all
            income is taxed at the Israeli statutory rate, and the actual tax
            expense, is as follows:

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                           ------------------------------
                                                                            2000        2001        2002
                                                                           ------      ------      ------
<S>                                                                         <C>         <C>         <C>
            Income before taxes as reported in the statements of income     3,069       3,619       2,533
                                                                           ======      ======      ======

            Tax rates                                                          36%         36%         36%
                                                                           ======      ======      ======

            Theoretical tax expense                                         1,105       1,303         912
            Increase (decrease) in taxes:
            Tax adjustments in respect of inflation in
               Israel                                                          --         214          11
            Non-deductible items, net                                        (126)         75         (24)
            Unrecognized tax losses                                            --          --         442
            Realized benefit of prior year's losses                          (371)         --          --
            Tax exemption applicable to "Approved
               Enterprises" and exempted income                              (126)       (928)       (293)
            Tax credits                                                      (256)         --          --
            Taxes in respect of prior years                                    --        (200)       (279)
            Other                                                             (46)        (12)       (124)
                                                                           ------      ------      ------

            Taxes on income in the statements of income                       180         452         645
                                                                           ======      ======      ======
            Net earnings per share amounts of the tax benefit
               from the exempt income:
            Basic and diluted                                                0.02        0.12        0.04
                                                                           ======      ======      ======
</TABLE>

            The tax rates of the Company's subsidiaries range between 35%-42%.

      f.    Taxes on income included in the statement of income:

                                                Year ended December 31,
                                                -----------------------
                                                2000     2001     2002
                                                ----     ----     ----
            Current taxes:
               Domestic                          365      500      269
               Foreign                            74      138      211

            Deferred income taxes:
               Domestic                           --      (39)     (30)
               Foreign                          (259)      53      474

            Taxes in respect of prior years:
               Domestic                           --     (200)    (279)
                                                ----     ----     ----

            Taxes on income                      180      452      645
                                                ====     ====     ====


                                      F-32
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 14:- TAXES ON INCOME (Cont.)

      g.    Deferred income taxes:

            Deferred income taxes reflect the net tax effects of temporary
            differences between the carrying amounts of assets and liabilities
            for financial reporting purposes and the amounts used for income tax
            purposes. Significant components of the Company and its subsidiaries
            deferred tax assets are as follows:

                                                                 December 31,
                                                              -----------------
                                                               2001       2002
                                                              ------     ------

            Operating loss carryforwards                         424      1,409
            Reserves and allowances                            1,988      1,308
                                                              ------     ------

            Total deferred assets before valuation allowance   2,412      2,717
            Valuation allowance                               (1,030)    (1,604)
                                                              ------     ------

            Net deferred tax assets                            1,382      1,113
                                                              ======     ======

            Domestic                                              39         69
            Foreign                                            1,343      1,044
                                                              ------     ------

                                                               1,382      1,113
                                                              ======     ======

      h.    The domestic and foreign components of income before taxes are as
            follows:

                                          Year ended December 31,
                                       -----------------------------
                                        2000        2001        2002
                                       -----       -----       -----

            Domestic                   2,424       3,320       2,217
            Foreign                      645         299         316
                                       -----       -----       -----

                                       3,069       3,619       2,533
                                       =====       =====       =====

      i.    Investment tax credit:

            One of the Company's subsidiaries is eligible for investment tax
            credits on its research and development activities and on certain
            current and capital expenditures. During fiscal year of 2002, the
            subsidiary recognized $304 of investment tax credits as a reduction
            of research and development expenses.

            In total, the subsidiary has investment tax credits available to
            reduce future federal income taxes payable, amounting to $618, which
            will expire at various dates from 2006 through 2011.


                                      F-33
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 14:- TAXES ON INCOME (Cont.)

      j.    Net operating losses carryforwards:

            As of December 31, 2002, the Company's subsidiaries in the U.S,
            Latin America and the United Kingdom had total net available
            carryforward tax losses of approximately $3,625.

            Utilization of U.S. net operating losses may be subject to a
            substantial annual limitation due to the "change in ownership"
            provisions of the Internal Revenue Code of 1986 and similar state
            provisions. The annual limitation may result in the expiration of
            net operating losses before utilization.

            As of December 31, 2002, net operating losses from subsidiaries in
            U.S. are approximately $2,733.

NOTE 15:- RELATED PARTIES TRANSACTIONS

                                                    Year ended December 31,
                                                    -----------------------
                                                     2000     2001    2002
                                                     ----     ----     ---

      Sales to related party                          211      261     111
                                                     ====     ====     ===

      In addition, see Note 12b.

NOTE 16:- SEGMENT INFORMATION AND SALES TO SIGNIFICANT CUSTOMERS

      a.    The Company develops, manufactures, markets and sells complex
            computerized security systems on a worldwide basis. These products
            are grouped into three major categories which represent the
            Company's operating and reportable segments as follows:

            1.    Perimeter Security Systems - The Company's line of perimeter
                  security systems consists of the following:
                  Microprocessor-based central control units, taut wire
                  perimeter intrusion detection systems, INNO Fences, vibration
                  detection systems and field disturbance sensors.

            2.    Security Turnkey Projects - The Company is executing turnkey
                  projects under the Company's security management system, and
                  acting as integrator.

            3.    Video monitoring services - The Company supplies Video
                  Monitoring Services through Smart Interactive Systems, Inc., a
                  subsidiary established in the U.S. in June 2001.

            The data is presented in accordance with SFAS 131, "Disclosure About
            Segments of an Enterprise and Related Information".


                                      F-34
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 16:- OPERATING SEGMENTS DATA (Cont.)

a.    The following data present the revenues, assets and other data of the
      Company's operating segments:

<TABLE>
<CAPTION>
                                                                  Year ended December 31,
                             ------------------------------------------------------------------------------------------------------
                                                 2000                                                  2001
                             -------------------------------------------    -------------------------------------------------------
                                                                                                      Video
                             Perimeter   Projects      Other       Total    Perimeter    Projects   monitoring    Other      Total
                             ---------   --------     ------      ------    ---------    --------   ----------    ------     ------
<S>                           <C>          <C>          <C>       <C>         <C>          <C>          <C>         <C>      <C>
Revenues                      33,910       3,802         859      38,571      34,893       5,004         142         981     41,020
                              ======      ======      ======      ======      ======      ======      ======      ======     ======

Depreciation and
   amortization                1,330           6          48       1,384       1,304           9          28          21      1,362
                              ======      ======      ======      ======      ======      ======      ======      ======     ======

Operating income,
   before  financial
   expenses and taxes on
   income                      2,473       1,234        (424)      3,283       2,583       2,478        (626)       (856)     3,579
                              ======      ======      ======                  ======      ======      ======      ======
Financial expenses                                                   214                                                        (40)
   (income), net
Taxes on income                                                      180                                                        452
                                                                   -----                                                      -----

Net income                                                         2,889                                                      3,167
                                                                   =====                                                      =====

<CAPTION>
                                               Year ended December 31,
                             --------------------------------------------------------
                                                       2002
                             --------------------------------------------------------
                                                      Video
                             Perimeter   Projects   monitoring    Other        Total
                             ---------   --------   ----------    ------      -------
<S>                           <C>          <C>        <C>         <C>          <C>
Revenues                      36,435       5,340         238         953       42,966
                              ======      ======      ======      ======      =======

Depreciation and
   amortization                  927           9         149          11        1,096
                              ======      ======      ======      ======      =======

Operating income,
   before  financial
   expenses and taxes on
   income                      2,316       2,656      (1,556)     (1,082)       2,334
                              ======      ======      ======      ======
Financial expenses
   (income), net                                                                 (199)
Taxes on income                                                                   645
                                                                                -----

Net income                                                                      1,888
                                                                                =====
</TABLE>

<TABLE>
<CAPTION>
                                                                       December 31,
                             -------------------------------------------------------------------------------------------------------
                                                 2000                                                  2001
                             -------------------------------------------    --------------------------------------------------------
                                                                                                      Video
                             Perimeter   Projects      Other       Total    Perimeter    Projects   monitoring    Other       Total
                             ---------   --------     ------      ------    ---------    --------   ----------    ------      ------
<S>                           <C>          <C>          <C>       <C>         <C>          <C>          <C>         <C>       <C>
Segment assets                12,500          27          58      12,585      11,911          18         324          30      12,283
                              ======      ======      ======      ======      ======      ======      ======      ======      ======

<CAPTION>
                                                   December 31,
                             --------------------------------------------------------
                                                       2002
                             --------------------------------------------------------
                                                      Video
                             Perimeter   Projects   monitoring    Other        Total
                             ---------   --------   ----------    ------      -------
<S>                           <C>          <C>        <C>         <C>          <C>
Segment assets                12,066          30         728          21       12,845
                              ======      ======      ======      ======      =======
</TABLE>


                                      F-35
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 16:- OPERATING SEGMENTS DATA (Cont.)

      b.    Major customer data (percentage of total revenues):

                                                      Year ended December 31,
                                                   ----------------------------
                                                    2000       2001       2002
                                                   ------     ------     ------
            Israeli Ministry of Defense and the
               Israeli Defense Forces                24.4%      22.5%      15.9%
                                                   ======     ======     ======

            The state concern civil aviation
               airlines "AZAL"                        2.0%      10.5%       1.8%
                                                   ======     ======     ======

      c.    Geographical information:

            The following is a summary of revenues within geographic areas based
            on end customer's location and long lived assets:

                                            Year ended December 31,
                                          --------------------------
                                           2000      2001      2002
                                          ------    ------    ------
            1. Revenues:

               Israel                     13,150    13,135    11,350
               Europe                      6,126     5,420     6,399
               USA                        10,721    11,358    12,641
               Azerbaijan                    789     4,577       756
               Canada                      1,860     2,035     4,324
               Others                      5,925     4,495     7,496
                                          ------    ------    ------

                                          38,571    41,020    42,966
                                          ======    ======    ======
            2. Long-lived assets:

               Israel                      3,664     3,623     3,566
               Europe                        776       666       786
               USA                         5,886     5,812     6,160
               Canada                      2,238     2,133     2,286
               Others                         21        49        47
                                          ------    ------    ------

                                          12,585    12,283    12,845
                                          ======    ======    ======


                                      F-36
<PAGE>

                                                     MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 17:- SELECTED STATEMENTS OF INCOME DATA

      a.    Research and development expenses, net:

<TABLE>
<CAPTION>
                                                       Year ended December 31,
                                                     ----------------------------
                                                      2000       2001       2002
                                                     ------     ------     ------
<S>                                                   <C>        <C>        <C>
            Expense                                   3,173      3,331      3,750
            Less - royalty-bearing grants and
               investment tax credit                    198        277        622
                                                     ------     ------     ------

                                                      2,975      3,054      3,128
                                                     ======     ======     ======

      b.    Financial income (expenses), net:

            Financial expenses:
               Interest on long-term debt              (294)      (398)      (371)
               Interest on short-term bank credit      (650)      (502)      (640)
               Foreign exchange losses                  (53)       (42)        (6)
                                                     ------     ------     ------

                                                       (997)      (942)    (1,017)
                                                     ------     ------     ------
            Financial income:
               From interest                            783        705        732
               Foreign exchange gains                    --        277        484
                                                     ------     ------     ------

                                                        783        982      1,216
                                                     ------     ------     ------

                                                       (214)        40        199
                                                     ======     ======     ======
</TABLE>

NOTE 18:- SUBSEQUENT EVENTS

      a.    In May 2003, the Company's Board of Directors decided to distribute
            a 3% stock dividend. This decision has not yet been approved by the
            annual general meeting of shareholders.

      b.    In April 2003, Rav-Tec Ltd filed a claim against the Company, the
            Ministry of Defense ("MOD") and a former employee of the Company. In
            the claim, Rav-Tec Ltd. alleges that the failure of a field trial by
            the MOD was due to intentional damages caused by the former employee
            and is seeking cash relief in the amount of about $730 for the
            aforesaid damages and that the court will annul the field trial. The
            Company denies the above allegations. In the opinion of the
            Company's attorneys, the Company has good defenses against the claim
            and, therefore, no provision in respect thereto was recorded in the
            financial statements.

                                - - - - - - - - -


                                      F-37
<PAGE>

                                    SIGNATURE

      The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.

                                        MAGAL SECURITY SYSTEMS LTD.


                                             By:    /s/ Jacob Even-Ezra
                                                    ----------------------------
                                             Name:  Jacob Even-Ezra
                                             Title: Chairman of the Board and
                                             Chief Executive Officer
                                             Date:  June 27, 2003


                                       82
<PAGE>

                                  EXHIBIT INDEX

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

      1.1*        Memorandum of Association of the Registrant

      1.2**       Articles of Association of the Registrant

      2.1***      Specimen Share Certificate for Ordinary Shares

      2.2****     The Registrant's Stock Option Plan (1993), as amended

      2.4*****    Form of Underwriters' Warrant Agreement

      2.5*****    Registration Rights Agreement, dated as of November 18, 1996,
                  by and among the Registrant, Mira Mag Inc., Israel Aircraft
                  Industries Ltd. and Jacob Even-Ezra

      10.1*****   Form of Underwriting Agreement

      21          List of Subsidiaries of the Registrant

      23.1        Consent of Kost Forer & Gabbay

      23.2        Consent of BDO Seidman, LLP

      99.1        Certification by Chief Executive Officer Pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002.

      99.2        Certification by Chief Financial Officer Pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002.

      99.3        Certification by Chief Executive Officer Pursuant to 18 U.S.C.
                  Section 1350, as Adopted Pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.

      99.4        Certification by Chief Financial Officer Pursuant to 18 U.S.C.
                  Section 1350, as Adopted Pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.

----------
*     Previously filed as an exhibit to our Registration Statement on Form F-1
      (No. 33-57438), filed with the Commission on January 26, 1993, as amended,
      and incorporated herein by reference.

**    Previously filed as an exhibit to our Registration Statement on Form F-1
      (No. 33-57438), filed with the Commission on January 26, 1993, as amended,
      and incorporated herein by reference and an amendment thereto previously
      filed as an exhibit to our Registration Statement on Form S-8 (No.
      333-6246), filed with the Commission on January 7, 1997 and incorporated
      herein by reference and further amendments thereto previously filed as an
      exhibit to our Annual Report on Form 20-F for the fiscal year ended
      December 31, 2000, filed with the Commission on June 29, 2001 and
      incorporated herein by reference.

***   Previously filed as an exhibit to our Registration Statement on Form 8-A,
      filed with the Commission on March 18, 1993, as amended, and incorporated
      herein by reference.

****  Previously filed as an exhibit to our Registration Statement on Form S-8
      (No. 333-6246), filed with the Commission on January 7, 1997 and
      incorporated herein by reference and further amendments thereto previously
      filed as an exhibit to our Annual Report on Form 20-F for the fiscal year
      ended December 31, 2000, filed with the Commission on June 29, 2001 and
      incorporated herein by reference.

<PAGE>

***** Previously filed as an exhibit to our Registration Statement on Form F-2
      (No.333-5970), filed with the Commission on November 8, 1996, as amended,
      and incorporated herein by reference.