---

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SECURITIES AND EXCHANGE COMMISSIONWashington D.C. 20549

FORM 20-F

|  |                                                                                                 
|- | ------------------------------------------------------------------------------------------------
|o | REGISTRATION STATEMENT PURSUANT TO
  SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|  | OR                                                                                              
|x | ANNUAL REPORT PURSUANT TO SECTION
  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934          
|  | For the fiscal year ended December 31, 2006                                                     
|  | OR                                                                                              
|o | TRANSITION REPORT PURSUANT TO
  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934      
|  | For the transition period from _________ to
  _________                                         
|  |                                                                                                 
|  | OR                                                                                              
|o | SHELL COMPANY REPORT PURSUANT TO
  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934   
|  | Date of event requiring this shell company
  report .                                      

Commission
file number: 0-21388

MAGAL SECURITY SYSTEMS LTD.

(Exact name of Registrant as specified in its
charter
and translation of Registrants name into English)

Israel

(Jurisdiction of incorporation or
organization)

P.O. Box 70, Industrial Zone, Yehud 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
|Ordinary Shares, NIS 1.0 Par Value |  | NASDAQ Global Market                     
|                                   |  | Tel Aviv Stock Exchange                  

Securities
registered or to be registered pursuant to Section 12(g) of the Act: None

Securities for
which there is a reporting obligation pursuant to Section 15(d) of the Act: None

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:

Ordinary Shares, par value NIS 1.0 per share
10,391,548(as of December 31, 2006)



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

Yes oNo x


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

Yes oNo x


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

Yes xNo o


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

Large accelerated filer oAccelerated
filer xNon-accelerated
filer o

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

Item 17 oItem 18 x


If this is an
annual report, indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act).

Yes oNo x


This Annual
Report on Form 20-F is incorporated by reference into the Registrants
Registration Statements on Form S-8, File Nos. 333-96929 and 333-127340.

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INTRODUCTION

Magal
Security Systems Ltd. develops, manufactures, markets and sells complex
computerized security systems, including a line of perimeter security systems,
a hardware and software all in one security solution which integrates closed
circuit television, or CCTV, related applications such as outdoor and indoor
video motion detection systems, security management and control systems,
personal emergency location systems, a pipeline security 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, in February 1997, we completed a public offering of an additional
2,085,000 ordinary shares and in April 2005, we completed a public offering of
an additional 1,700,000 ordinary shares. Our ordinary shares are traded on the
NASDAQ Global 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.

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.

We
have trademark rights in the United States and other national jurisdictions
arising out of our trademark registrations, applications, and/or use of the
following trademarks and service marks: SENSTAR-STELLAR logo, the S logos,
SENSTAR-STELLAR, SENSTAR-STELLAR (and design) SENSTAR, STELLAR, STELLAR
SYSTEMS, STELLAR SYSTEMS (and design), PANTHER, GUIDAR, REPELS, SENNET,
PERIMITRAX, INTELLI-FLEX, INTELLI-FIELD, X-FIELD, OMNITRAX, STARLED, STARNET,
FRONTLINE, E-FIELD, H-FIELD, E-FLEX, ARMOURFLEX, SIMPL, CROSSFIRE, ECHOCHECK,
FLASH, FLARE,SENTRAX,
OMNITRAX and XFIELD and all other marks used to identify particular products
and services associated with our businesses.

Any
other trademarks and trade names appearing in this annual report are owned by
their respective holders.

Our
address on the Internet is www.magal-ssl.com. The information on our website is
not incorporated by reference into this annual report.

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 21, 2007 was NIS 4.230 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.

---

---



TABLE OF CONTENTS

|          |                                                         |                                                           |         
|--------- | ------------------------------------------------------- | --------------------------------------------------------- | --------
|          |                                                         |                                                           | Page No.
|          |                                                         |                                                           |         
|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                                | 25      
|          | D.                                                      | Property, Plants and
  Equipment                          | 25      
|ITEM 4A.  | Unresolved Staff
Comments                               | 26                                                       
|ITEM 5.   | Operating and Financial Review and
  Prospects          | 26                                                       
|          | A.                                                      | Operating Results                                         | 34      
|          | B.                                                      | Liquidity and Capital Resources                           | 41      
|          | C.                                                      | Research and Development, Patents and Licenses            | 44      
|          | D.                                                      | Trend Information                                         | 45      
|          | E.                                                      | Off-Balance Sheet Arrangements                            | 45      
|          | F.                                                      | Tabular Disclosure of Contractual Obligations             | 45      
|ITEM 6.   | Directors, Senior Management and
Employees              | 46                                                       
|          | A.                                                      | Directors and Senior
  Management                         | 46      
|          | B.                                                      | Compensation                                              | 49      
|          | C.                                                      | Board
  Practices                                         | 49      
|          | D.                                                      | Employees                                                 | 57      
|          | E.                                                      | Share Ownership                                           | 58      
|ITEM 7.   | Major Shareholders and Related Party
  Transactions     | 59                                                       
|          | A.                                                      | Major
  Shareholders                                      | 59      
|          | B.                                                      | Related
  Party Transactions                              | 61      
|          | C.                                                      | Interests
  of Experts and Counsel                        | 62      
|ITEM 8.   | Financial Information                                   | 62                                                       
|          | A.                                                      | Consolidated
  Statements and Other Financial Information | 62      
|          | B.                                                      | Significant
  Changes                                     | 63      
|ITEM 9.   | The Offer and Listing                                   | 64                                                       
|          | A.                                                      | Offer and Listing
  Details                               | 64      
|          | B.                                                      | Plan of Distribution                                      | 65      
|          | C.                                                      | Markets                                                   | 65      
|          | D.                                                      | Selling Shareholders                                      | 65      
|          | E.                                                      | Dilution                                                  | 65      
|          | F.                                                      | Expenses of the Issue                                     | 65      
|ITEM 10.  | Additional
Information                                  | 65                                                       
|          | A.                                                      | Share Capital                                             | 65      
|          | B.                                                      | Memorandum and Articles
  of Association                  | 65      
|          | C.                                                      | Material
  Contracts                                      | 70      
|          | D.                                                      | Exchange
  Controls                                       | 70      
|          | E.                                                      | Taxation                                                  | 70      
|          | F.                                                      | Dividends
  and Paying Agents                             | 83      

i

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|          |                                                                                |                          |   
|--------- | ------------------------------------------------------------------------------ | ------------------------ | --
|          | G.                                                                             | Statements
  by Experts  | 83
|          | H.                                                                             | Documents
  on Display   | 83
|          | I.                                                                             | Subsidiary
  Information | 83
|ITEM 11.  | Quantitative and Qualitative
Disclosures
  about Market Risk                   | 83                      
|ITEM 12.  | Description of Securities Other
Than Equity
  Securities                       | 85                      
|PART II   |                                                                                |                          | 85
|ITEM 13.  | Defaults, Dividend Arrearages and
  Delinquencies                              | 85                      
|ITEM 14.  | Material Modifications to the
Rights of
  Security Holders and Use of Proceeds | 85                      
|ITEM 15.  | Controls and
Procedures                                                        | 85                      
|ITEM 15T. | Controls and
Procedures                                                        | 86                      
|ITEM 16A. | Audit Committee Financial
Expert                                               | 87                      
|ITEM 16B. | Code of Ethics                                                                 | 87                      
|ITEM 16C. | Principal Accountant Fees and
Services                                         | 87                      
|ITEM 16D. | Exemptions from the Listing
Standards for
  Audit Committee                    | 88                      
|ITEM 16E. | Purchase of Equity Securities by
the Issuer
  and Affiliated Purchasers        | 88                      
|PART III  |                                                                                |                          | 88
|ITEM 17.  | Financial Statements                                                           | 88                      
|ITEM 18.  | Financial Statements                                                           | 88                      
|ITEM 19.  | Exhibits                                                                       | 89                      
|SIGNATURE | 90                                                                            

ii

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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, 2005
and 2006 and for each of the years ended December 31, 2004, 2005 and 2006 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, 2002, 2003 and 2004 and for each of the years ended
December 31, 2002 and 2003 from our audited consolidated financial statements not included
in this annual report. We have determined that as of October 1, 2006 our functional currency has changed
from the U.S. dollar to the NIS, but the U.S. dollar remains as our reporting currency. 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.

|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ------ | - | ---- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                                              |  | Year Ended December 31,              |       
|                                                                                              |  |                                      |       
|                                                                                              |  | 2002                                 |        | 2003 |   | 2004   |   | 2005 |        | 2006 |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |  
|                                                                                              |  | (in thousands except per share data) |       
|Consolidated Statement of Income Data:                                                        |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Revenues                                                                                      |  | $                                    | 42,376 |      | $ | 58,655 |   | $    | 60,468 |      | $ | 61,282 |   | $ | 66,958 |  
|Cost of revenues                                                                              |  |                                      | 23,458 |      |   | 32,847 |   |      | 33,226 |      |   | 39,154 |   |   | 40,231 |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Gross profit                                                                                  |  |                                      | 18,918 |      |   | 25,808 |   |      | 27,242 |      |   | 22,128 |   |   | 26,727 |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Operating expenses:                                                                           |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Research and development, net                                                                 |  |                                      | 3,128  |      |   | 4,773  |   |      | 4,683  |      |   | 5,265  |   |   | 5,378  |  
|Selling and marketing, net                                                                    |  |                                      | 8,511  |      |   | 11,427 |   |      | 12,519 |      |   | 13,180 |   |   | 12,079 |  
|General and administrative                                                                    |  |                                      | 4,938  |      |   | 5,305  |   |      | 5,771  |      |   | 5,961  |   |   | 6,533  |  
|Award granted by principal shareholders                                                       |  |                                      | -      |      |   | -      |   |      | 1,200  |      |   | -      |   |   | -      |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Total operating expenses                                                                      |  |                                      | 16,577 |      |   | 21,505 |   |      | 24,173 |      |   | 24,406 |   |   | 23,990 |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Operating income (loss)                                                                       |  |                                      | 2,341  |      |   | 4,303  |   |      | 3,069  |      |   | (2,278 | ) |   | 2,737  |  
|Financial income (expenses), net                                                              |  |                                      | 199    |      |   | (1,003 | ) |      | (762   | )    |   | (800   | ) |   | (851   | )
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Income (loss) before income taxes                                                             |  |                                      | 2,540  |      |   | 3,300  |   |      | 2,307  |      |   | (3,078 | ) |   | 1,886  |  
|Income taxes (tax benefit)                                                                    |  |                                      | 646    |      |   | 910    |   |      | 1,133  |      |   | (23    | ) |   | 948    |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Income (loss) from continuing operations                                                      |  |                                      | 1,894  |      |   | 2,390  |   |      | 1,174  |      |   | (3,055 | ) |   | 938    |  
|Gain (loss) from discontinued operations, net                                                 |  |                                      | (6     | )    |   | 14     |   |      | (121   | )    |   | (156   | ) |   | (128   | )
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Net income (loss)                                                                             |  |                                      | 1,888  |      |   | 2,404  |   |      | 1,053  |      |   | (3,211 | ) |   | 810    |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Basic net earnings (loss) per share from continuing
operations                                |  | $                                    | 0.24   |      | $ | 0.30   |   | $    | 0.13   |      | $ | (0.31  | ) | $ | 0.09   |  
|Basic net loss per share from discontinued operations                                         |  |                                      | -      |      |   | -      |   |      | (0.01  | )    |   | (0.01  | ) |   | (0.01  | )
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Basic net earnings (loss) per share                                                           |  | $                                    | 0.24   |      | $ | 0.30   |   | $    | 0.12   |      | $ | (0.32  | ) | $ | 0.08   |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Diluted net earnings (loss) per share from continuing
operations                              |  | $                                    | 0.23   |      | $ | 0.30   |   | $    | 0.13   |      | $ | (0.31  | ) | $ | 0.09   |  
|Diluted net loss per share from discontinued operations                                       |  |                                      | -      |      |   | -      |   |      | (0.01  | )    |   | (0.01  | ) |   | (0.01  | )
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Diluted net earnings (loss) per share                                                         |  | $                                    | 0.23   |      | $ | 0.30   |   | $    | 0.12   |      | $ | (0.32  | ) | $ | 0.08   |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  
|Weighted average number of ordinary shares used in computing basic
net
  earnings per share   |  |                                      | 7,866  |      |   | 7,948  |   |      | 8,581  |      |   | 9,883  |   |   | 10,384 |  
|Weighted average number of ordinary shares used in computing diluted
  net earnings per share |  |                                      | 8,069  |      |   | 8,029  |   |      | 8,636  |      |   | 9,900  |   |   | 10,442 |  
|Cash dividend per share                                                                       |  | $                                    | -      |      | $ | 0.05   |   | $    | -      |      | $ | -      |   | $ | -      |  
|                                                                                              |  |                                      |        |      |   |        |   |      |        |      |   |        |   |   |        |  

1

---

---



Our
Board of Directors declared share dividend distributions of 3.0%,
3.0% and 5.0% in May 2002, May 2003 and July 2004, respectively. All per share
data in the above table has been adjusted to reflect the share dividends.

On July
28, 2005, we decided to dispose of our indoor security sensors operations. Accordingly, the operating results and cash flows attributed to the indoor security
sensors operations were presented in our statements of income and cash flows as
discontinued operations, and the comparative figures were reclassified for all periods
presented.

|                                                                                |  |                    |        |      |   |        |  |      |        |      |   |         |  |   |         | 
|------------------------------------------------------------------------------- |  | ------------------ | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------- |  | - | ------- | 
|                                                                                |  | As of December 31, |       
|                                                                                |  |                    |       
|                                                                                |  | 2002               |        | 2003 |   | 2004   |  | 2005 |        | 2006 |  
|                                                                                |  |                    |        |      |   |        |  |      |        |      |  
|                                                                                |  | (in thousands)     |       
|                                                                                |  |                    |        |      |   |        |  |      |        |      |   |         |  |   |         | 
|Consolidated Balance Sheet Data:                                                |  |                    |        |      |   |        |  |      |        |      |   |         |  |   |         | 
|Cash and cash equivalents                                                       |  | $                  | 2,519  |      | $ | 4,389  |  | $    | 11,964 |      | $ | 10,099  |  | $ | 4,908   | 
|Short and long-term bank
  deposits, marketable securities and structured notes |  |                    | 12,357 |      |   | 12,051 |  |      | 5,994  |      |   | 18,853  |  |   | 22,053  | 
|Working capital                                                                 |  |                    | 15,688 |      |   | 21,401 |  |      | 21,603 |      |   | 35,454  |  |   | 39,717  | 
|Total assets                                                                    |  |                    | 59,741 |      |   | 71,443 |  |      | 77,976 |      |   | 101,842 |  |   | 103,681 | 
|Short-term bank credit
  (including current maturities of long-term loans)      |  |                    | 10,357 |      |   | 16,438 |  |      | 17,467 |      |   | 21,715  |  |   | 17,821  | 
|Long-term bank loans                                                            |  |                    | 4,698  |      |   | 1,873  |  |      | 3,500  |      |   | 1,653   |  |   | 7,399   | 
|Total shareholders equity                                                      |  |                    | 35,031 |      |   | 38,984 |  |      | 43,548 |      |   | 56,950  |  |   | 58,150  | 

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

We depend on large orders from a relatively
small number of customers for a substantial portion of our revenues. As a
result, our revenues and operating results may vary from quarter to quarter.

We
receive large orders from a relatively small number of customers and our
revenues and operating results are subject to substantial periodic variations.
Individual orders from customers can represent a substantial portion of our
revenues in any one period and significant orders by a customer during one
period may not be followed by further orders from the same customer in
subsequent periods. As a result, our revenues and operating results for a
specific quarter may not be indicative of our future performance and
quarter-to-quarter comparisons of our operating results may not be meaningful,
making it difficult for investors to evaluate our future prospects based on the
results of any quarter.

2

---

---



In
addition, we have a limited order backlog, which makes revenues in any quarter
substantially dependent upon orders we deliver in that quarter.

Our revenues depend on government procurement
procedures and practices. A substantial decrease in our customers budgets would
adversely affect our results of operations.

Our
products are primarily sold to governmental agencies, governmental 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 governmental 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 decrease in governmental funding for our customers budgets would
adversely affect our results of operations.

The loss of one or more of our key customers,
in particular the Israeli Ministry of Defense, would result in a loss of a
significant amount of our revenues.

A
relatively few customers account for a large percentage of our revenues. For
the years ended December 31, 2004, 2005 and 2006, revenues generated from sales
to the Israeli Ministry of Defense, or MOD, accounted for 7.8%, 23.9% and 33.7%, respectively, of our revenues. The
loss of the MOD as a customer without replacement by a customer or customers of
similar volume would have a material adverse effect on our financial results.

We have initiated an arbitration proceeding
against a customer in Eastern Europe to recover funds payable to us under the
terms of a turnkey project. In the event we are unsuccessful in this
arbitration, our financial results will be adversely affected.

In
May 2005 we entered into an agreement to supply comprehensive security
solutions for a sensitive site in Eastern Europe. As part of the agreement, we
received an advance payment, secured by a bank advanced payment guarantee that
was to be reduced proportionally as execution of the project progressed. In
addition, we issued the customer a performance bank guarantee. We commenced the
project and delivered some of the equipment and other deliverables to the customer
in 2005. In April 2006, the customer informed us that it was canceling the
agreement due to errors in the design documents that we submitted. In addition,
the customer did not make payments required under the agreement. Based on its
cancellation of the agreement, the customer collected $3.2 million under the
advanced payment guarantee on June 20, 2006. Due to this uncertainty, we did
not recognize any revenues from this project.

On
July 11, 2006 the customer made a demand for additional $1.4 million payment
under a bank performance guarantee for. Upon our motion, the District Court in
Haifa, Israel issued a temporary injunction against the payment of such
guarantee pending a hearing in August 2006. At the hearing, we reached a
settlement with the customer pursuant to which we paid the customer
approximately $700,000 of the disputed amount and the balance will be repaid
only if we are found liable for damages exceeding the amount paid by us. In
view of the above and due to the uncertainty of our preventing the forfeiture
of the bank performance guarantee, we included a $1.4 million provision in
respect of this guarantee in our financial statements for the year ended
December 31, 2005. Based on the settlement, we cancelled the balance of the provision
made in our financial statements in 2006. In the event we will be unsuccessful in the arbitration, we may be
required to record an expense of $700,000 if the customer will be allowed to
enforce the bank performance guarantee.

3

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---



We
believe that there is no factual or legal ground for the cancellation of the
agreement or the demand for payment under the bank performance guarantee, and
accordingly, we believe that the agreement is still valid. On April 28, 2006,
we commenced arbitration proceedings against the customer. In these proceedings
we asked the arbitrators to find that the agreement is valid and to enforce the
payments due to us pursuant to the agreement. The customer denied our
allegations and filed a counter-claim for liquidated damages in a foreign
currency which on December 31, 2006 was equal to approximately $4.5 million.
The hearing of the arbitration proceeding has concluded and is pending
resolution by the arbitration panel. Based on the opinion of our legal counsel,
we believe that there is a good likelihood that the arbitration will result in
a favorable determination. We intend to vigorously pursue our claim. However,
we may not be successful in the arbitration, which may result in a significant
negative impact on our financial results including the payment of penalties.

The level of our contracts may be reduced in
the future due to changes in governmental priorities and audits.

Governmental
purchases of our systems, products and services may decline in the future as
the governmental purchasing agencies may terminate, reduce or modify contracts
or subcontracts if:

| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | Their
  requirements or budgetary constraints change;                             
| |   |                                                                                   
| |  | they cancel
  multi-year contracts and related orders if funds become unavailable;
| |   |                                                                                   
| |  | they shift
  spending priorities into other areas or for other products; and      
| |   |                                                                                   
| |  | they adjust
  contract costs and fees on the basis of audits.                     

Any
such event may have a material adverse affect on us.

If we do not receive MOD 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 the
export of certain of our know-how are 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 may not be able to
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.

Our wholly-owned subsidiary, Smart
Interactive Systems, Inc., may never achieve a profit. If Smart continues to
incur losses, our future results of operations will be adversely affected.

In
2001, we established Smart Interactive Systems, Inc., or Smart, to meet the
growing demand for real-time video monitoring services for use in industrial
sites, commercial businesses and VIP residences. We have invested $15.5million in Smart through December 31, 2006. Smarts
operations to
date have not been profitable, and Smart has an accumulated deficit of $7.8million as of December 31, 2006. If Smart
is unable to market its services successfully or if its services fail to
penetrate the market, we may lose our investment in this company and our future
results of operations will be adversely affected.

4

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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 features that keep pace with technological developments and
emerging industry standards and address the increasingly sophisticated needs of
our customers.

In
the future:

| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we may not
  be successful in developing and marketing new products or product features
  that respond to technological change or evolving industry standards;
| |   |                                                                                                                                                               
| |  | we may
  experience difficulties that could delay or prevent the successful
  development, introduction and marketing of these new products and features;
  or
| |   |                                                                                                                                                               
| |  | our new
  products and product features may not adequately meet the requirements of the
  marketplace and achieve market acceptance.                          

If
we are unable to respond promptly and effectively to changing technology, we
will be unable to compete effectively in the future.

We face risks associated with doing business
in international markets.

A
large portion of our sales is to markets outside of Israel (68.5% of our sales
in 2005 and 60.6% of our sales in 2006), and a key component of our strategy is
to continue to expand in such markets, the most significant of which currently
are North America, Europe, 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:

| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | unexpected
  changes in regulatory requirements;                      
| |   |                                                                       
| |  | currency
  fluctuations;                                              
| |   |                                                                       
| |  | export
  restrictions, tariffs and other trade barriers;              
| |   |                                                                       
| |  | unexpected
  difficulties in staffing and managing foreign operations;
| |   |                                                                       
| |  | longer
  payment cycles;                                              
| |   |                                                                       
| |  | difficulties
  in collecting accounts receivable;                     
| |   |                                                                       
| |  | political
  instability; and                                          
| |   |                                                                       
| |  | seasonal
  reductions in business activities.                         

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

We may be adversely affected by our long
sales cycles.

We
have in the past and expect in the future to experience long time periods
between initial sales contacts and the execution of formal contracts for our
products and completion of product installations. The cycle from first contact
to revenue generation in our business involves, among other things, selling the
concept of our technology and products, developing and implementing a pilot
program to demonstrate the capabilities and accuracy of our products,
negotiating prices and other contract terms, and, finally, installing and
implementing our products on a full-scale basis. This cycle entails a substantial
period of time, sometimes as much as one or more years, and the lack of
revenues during this cycle and the expenses involved in bringing new sales to
the point of revenue generation may put a substantial strain on our resources.

5

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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. We currently have
no commitments or agreements with respect to any acquisitions or investments
and we may not be able to 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 making acquisitions and managing
growth. We may not be able to realize the anticipated benefits of any
acquisition. Moreover, 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 identifiable
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 approximately 46 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, distributors and agents, suppliers and subcontractors. 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
asserting 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.

6

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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. We may not be able to obtain such items from
these suppliers and subcontractors on satisfactory terms in the future.
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.

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. Despite testing by us and our
customers, errors may 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 may 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.

We depend on our senior management and key
personnel, particularly Izhar Dekel, our president and chief executive officer,
and his loss 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 depend on the services of Mr.
Dekel, our president and chief executive officer. We carry key person life
insurance for Mr. Dekel. Any loss of the services of 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 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.

7

---

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Risks Relating to Our Ordinary Shares

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:

| |   |                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------
| |  | political,
  economic and other developments in the State of Israel;                                 
| |   |                                                                                                      
| |  | terrorist
  attacks and other acts of war, and any response to them;                                 
| |   |                                                                                                      
| |  | actual or
  anticipated variations in our quarterly operating results or those of our
  competitors; 
| |   |                                                                                                      
| |  | announcements
  by us or our competitors of technological innovations or new and enhanced
  products;
| |   |                                                                                                      
| |  | developments
  or disputes concerning proprietary rights;                                            
| |   |                                                                                                      
| |  | introduction
  and adoption of new industry standards;                                               
| |   |                                                                                                      
| |  | changes in
  financial estimates by securities analysts;                                             
| |   |                                                                                                      
| |  | market
  conditions or trends in our industry;                                                       
| |   |                                                                                                      
| |  | changes in
  the market valuations of our competitors;                                               
| |   |                                                                                                      
| |  | announcements
  by us or our competitors of significant acquisitions;                                
| |   |                                                                                                      
| |  | entry into
  strategic partnerships or joint ventures by us or our competitors; and                  
| |   |                                                                                                      
| |  | additions or
  departures of key personnel.                                                          

In
addition, the stock market in general, and the market for Israeli companies and
home defense 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.

Risks 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. Accordingly,
we are directly influenced by the political, economic and military conditions
affecting Israel. Specifically, we could be adversely affected by any major
hostilities involving Israel, a full or partial mobilization of the reserve
forces of the Israeli army, the interruption or curtailment of trade between
Israel and its present trading partners, and 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 a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. Although Israel has entered into
various agreements with Egypt, Jordan and the Palestinian Authority, there has
been an increase in unrest and terrorist activity in Israel, which began in
September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces
in Lebanon, which involved rocket attacks on populated areas in the northern
parts of Israel. On August 14, 2006, a cease-fire between Hezbollah and Israel
took effect. This situation has had an adverse effect on Israels economy,
primarily in the geographical areas directly harmed by this conflict. Any
future armed conflict, political instability or violence in the region may have
a negative effect on our business condition, harm our results of operations and
adversely affect our share price. No predictions can be made as to whether or
when a final resolution of the areas problems will be achieved or the nature
thereof and to what extent the situation will impact Israels economic
development or our operations.

8

---

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Furthermore,
there are a number of countries, primarily in the Middle East, as well as
Malaysia and Indonesia, that restrict business with Israel or Israeli
companies, and we are precluded from marketing our products to these countries.
Restrictive laws or policies directed towards Israel or Israeli businesses may
have an adverse impact on our operations, our financial results or the
expansion of our business.

Our results of operations may be negatively
affected by the obligation of our personnel to perform military service.

Many
of our executive officers and employees in Israel are obligated to perform
annual reserve duty in the Israeli Defense Forces, or IDF, and are subject to
being called for active duty under emergency circumstances at any time. If a
military conflict or war arises, these individuals could be required to serve
in the military for extended periods of time. Our operations could be disrupted
by the absence for a significant period of one or more of our executive officers
or key employees or a significant number of other employees due to military
service. Any disruption in our operations could adversely affect our business.

We may be adversely affected by a change in
the exchange rate of the New Israeli Shekel against the dollar.

Because
exchange rates between the NIS, our functional currency, and the dollar
fluctuate continuously, exchange rate fluctuations, particularly larger
periodic devaluations, may have an impact on our profitability and
period-to-period comparisons of our results. In 2002 and 2005 the rate of
devaluation of the NIS against the dollar was 7.3% and 6.8% respectively, while
in 2003, 2004 and 2006 the NIS appreciated in value in relation to the dollar
by 7.6% 1.6% and 8.2%, respectively. A portion of our expenses, primarily labor
expenses, is incurred in NIS and a part of our revenues are quoted in NIS.
Additionally, certain assets, as well as a portion of our liabilities, are
denominated in NIS. Our results may be adversely affected by the devaluation of
the NIS in relation to the dollar (or if such devaluation is on lagging basis),
if our revenues in NIS are higher than our expenses in NIS and/or the amount of
our assets in NIS are higher than our liabilities in NIS. Alternatively, our
results may be adversely affected by an appreciation of the NIS in relation to
the dollar (or if such appreciation is on a lagging basis), if the amount of
our expenses in NIS are higher than the amount of our revenues in NIS and/or
the amount of our liabilities in NIS are higher than our assets in NIS.

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

We
currently receive grants and tax benefits under Israeli government programs, we
must continue to meet specified conditions, including, but not limited to,
making specified investments from our equity 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, including any
accrued interest, or pay increased taxes or royalties. The Israeli government
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 Israeli government ends these programs and benefits, our business,
financial condition, results of operations and net income could be materially
adversely affected.

9

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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.

We
have been granted the status of an approved enterprise for 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
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
residents. 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
and interest 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.

Your rights and responsibilities as a
shareholder will be governed by Israeli law and differ in some respects from
the rights and responsibilities of shareholders under U.S. law.

We
are incorporated under Israeli law. The rights and responsibilities of holders
of our ordinary shares are governed by our memorandum of association, articles
of association and by Israeli law. These rights and responsibilities differ in
some respects from the rights and responsibilities of shareholders in typical
U.S. corporations. In particular, shareholder of an Israeli company has a duty
to act in good faith in exercising his or her rights and fulfilling his or her
obligations toward the company and other shareholders and to refrain from
abusing his power in the company, including, among other things, in voting at
the general meeting of shareholders on certain matters. Israeli law provides
that these duties are applicable in shareholder votes on, among other things,
amendments to a companys articles of association, increases in a companys
authorized share capital, mergers and interested party transactions requiring
shareholder approval. In addition, a controlling shareholder of an Israeli company
or a shareholder who knows that it possesses the power to determine the outcome
of a shareholder vote or who has the power to appoint or prevent the
appointment of a director or executive officer in the company has a duty of
fairness toward the company. However, Israeli law does not define the substance
of this duty of fairness. Because Israeli corporate law has undergone extensive
revision in recent years, there is little case law available to assist in
understanding the implications of these provisions that govern shareholder
behavior.

It may be difficult to enforce a non-Israeli
judgment against us, our officers and directors.

All
of our executive officers and directors are nonresidents of the United States,
and a substantial portion of our assets and the assets of these persons are
located outside the United States. Therefore, it may be difficult for an
investor, or any other person or entity, to enforce against us or any of those
persons in an Israeli court a U.S. court judgment based on the civil liability
provisions of the U.S. federal securities laws. It may also be difficult to
effect service of process on these persons in the United States. Additionally,
it may be difficult for an investor, or any other person or entity, to enforce
civil liabilities under U.S. federal securities laws in original actions filed
in Israel.

10

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As a foreign private issuer whose shares are
listed on the NASDAQ Global Market,
we may follow certain home country corporate governance practices instead of
certain NASDAQ requirements.

As
a foreign private issuer whose shares are listed on The NASDAQ Global Market,
we are permitted to follow certain home country corporate governance practices
instead of certain requirements of the NASDAQ Marketplace Rules. A foreign
private issuer that elects to follow a home country practice instead of such
requirements must submit to NASDAQ in advance a written statement from an
independent counsel in such issuers home country certifying that the issuers
practices are not prohibited by the home countrys laws. In addition, a foreign
private issuer must disclose in its annual reports filed with the Securities
and Exchange Commission each such requirement that it does not follow and
describe the home country practice followed by the issuer instead of any such
requirement. As a foreign private issuer listed on The NASDAQ Global Market, we
may follow home country practice with regard to, among other things,
composition of the board of directors, director nomination procedure,
compensation of officers, and quorum at shareholders meetings. In addition, we
may follow our home country law, instead of the NASDAQ Marketplace Rules, which
require that we obtain shareholder approval for certain dilutive events, such
as for the establishment or amendment of certain equity based compensation
plans, an issuance that will result in a change of control of the company,
certain transactions other than a public offering involving issuances of a 20%
or more interest in the company and certain acquisitions of the stock or assets
of another company.

|        |                           
|------- | --------------------------
|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 Yehud Industrial Zone. Our mailing address is P.O. Box 70,
Industrial Zone, Yehud 56100, Israel and our telephone number is
972-3-539-1444. Our agent for service of process in the U.S. is Magal Senstar
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
reference into this annual report.

We
develop, manufacture, market and sell complex computerized security systems,
including a line of perimeter security systems, a hardware and software all in
one security solution which integrates CCTV, related applications such as
outdoor and indoor video motion detection systems, security management and
control systems, personal emergency location systems and a pipeline security
system. We also provide video monitoring services through our Smart subsidiary.

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

11

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

General

We
develop, manufacture, market and sell complex computerized security systems.
Our systems are used in more than 75 countries to protect sensitive facilities,
including national borders, military bases, power plant installations,
airports, postal facilities, prisons, industrial locations and municipalities
from terrorism, theft and other threats. Our revenues are principally derived
from:

|  |                                                                                                                                                                                                                                                                                   
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a line of
  perimeter security systems, which automatically detect and locate intruders,
  identify the nature of intrusions and provide emergency notification;                                                                                                                  
|  |                                                                                                                                                                                                                                                                                   
| | turnkey
  projects based on security management, command and control systems, which
  integrate the management, control and display of various security systems
  into a single, real-time database and support real-time decision making and
  wide area command and control; and
|  |                                                                                                                                                                                                                                                                                   
| | video
  monitoring 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 enhance our current products and
develop new products to meet those needs. We intend to continue to focus on
developing new products, expanding the capabilities of existing products and
making custom enhancements for specific projects. We believe that the addition
of DreamBox, Fortis and PipeGuard to our product offerings has substantially
broadened our potential markets and we have begun to recognize revenues from
these products.

Enter
New Markets and Strengthen Presence in Existing Markets.
In 2007 we intend to continue to penetrate new geographic markets by various
means, including the establishment of alliances with local distributors. In
June 2007 we established a new strategic partnership in Brazil. The new strategic
partnership will provide local consultants and integrators with complete
perimeter solutions, technical support and a local service center. 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 security management and control systems and Dreambox all in
one CCTV security solution, we now offer comprehensive turnkey security
solutions that provide a comprehensive security implementation process. This
process entails:

| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | in-depth
  threat analysis;                                                                                      
| |   |                                                                                                                  
| |  | determination
  of the appropriate hardware and software solutions;                                              
| |   |                                                                                                                  
| |  | training
  sessions for systems operators; and                                                                   
| |   |                                                                                                                  
| |  | upon
  customer approval, integration of the required systems into our security
  management and control systems.

12

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We
believe that the market for turnkey security solutions presents a significant
opportunity. We are emphasizing our ability to offer turnkey solutions in
keeping with our objective of becoming a leading provider of comprehensive
security solutions.

Products and Services

Perimeter
Security 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.

Our
line of perimeter security systems consists of the following:

| |   |                                                   
| | - | --------------------------------------------------
| |  | taut wire
  perimeter intrusion detection systems;
| |   |                                                   
| |  | vibration
  detection systems; and                
| |   |                                                   
| |  | 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 thousands of kilometers of
borders and facility boundaries throughout the world, including more than 600
correctional institutions in the U.S. and correctional institutions in several
other countries. In addition, we have installed several hundred miles of high
security electronic perimeter systems along Israels borders.

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. We use taut wire perimeter systems as both an integral component of
intruder detection systems and as a physical barrier to infiltration.

Our
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 perimeter 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 perimeter 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
perimeter systems along Israels borders to assist in preventing unauthorized
entry and infiltration. Our taut wire perimeter systems are sold for
approximately $50-$100 per meter.

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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 perimeter systems, such as chain link or
welded mesh. In our BARRICADE 500 system, 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,
Intelli-FIBER and fence protection systems, or FPS, microprocessor-based
triboelectric and Electret cable fence sensors are vibration sensitive
transducers. These systems detect any attempt to cut, climb or penetrate the
fence and 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
system is sold for between $15-$30 per meter.

Field
Disturbance Sensors

We offer a number of types of
field disturbance sensors that detect intrusions before the intruder touches
the sensor.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  Intelli-Field volumetric electronic field disturbance sensor can be installed
  outdoors on perimeter systems, buildings or as free-standing units. The
  Intelli-Field system is sold for approximately $95-$156 per meter.                                                                                                                                                                                                                                                                                                                                                                                                                     
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | 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. The Perimitrax system is sold for
  approximately $70-$170 per meter.                                                                                                                                                                                                                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | Omnitrax is
  a fifth generation, covert outdoor perimeter security intrusion detection
  sensor that generates an invisible radar detection field around buried sensor
  cables. An alarm is emitted and the exact location identified within one
  meter if an intruder disturbs the field. Targets are detected by their
  conductivity, size and movement and the digital processor is able to filter
  out common alarms caused by environmental conditions and small animals. The
  Omnitrax system is sold for approximately $57-$176 per meter.                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | X-Field is a terrain following, volumetric
  sensor that creates an electrostatic field around a set of 4 or 8 parallel
  field and sense wires. These wires can be mounted on free-standing poles,
  existing fences, walls or rooftops and will sense changes, via the processor,
  in the electrostatic field when events such as intruders penetrating through
  the wires takes place. The systems tall, narrow, well contained detection
  zone allows the sensor to be installed in almost any application and
  minimizes nuisance alarms caused by nearby moving objects. The X-Field system is sold
  for approximately $114-$190 per meter.

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We
have installed high-security taut wire electronic perimeter systems over
several hundred kilometers of Israels borders and have sold a number of our
high-security perimeter systems to protect other locations in Israel, including
Ben-Gurion International Airport, facilities of IAI and the Israel Electric
Company, the Israeli parliament, or the Knesset, industrial plants, prisons and
military bases. Outside Israel, our high-security perimeter 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, North America, 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 grounds from outside. Most of these airports utilize a
system manufactured by us. In marketing our high-security perimeter systems, we
target authorities responsible for airport security. To date, we have sold and
installed perimeter systems 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 perimeter systems around airports. However, we cannot
assure you that any revenues will result from these negotiations.

Our
high-security perimeter 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 perimeter
systems have already been installed in prisons in Australia, Europe, Israel,
North America and the Far East.

Ten
models of our perimeter intrusion detection sensors have been approved by the
U.S. Department of the Air Force for use in the $498 million Force Protection
Integrated Base Defense Security System, or IBDSS, program. The IBDSS program
includes intrusion detection systems designed to prevent unauthorized entry or
access to large, medium and small military facilities. The IBDSS program to
protect classified facilities was initiated in October 2003 and is scheduled
for completion in September 2008. Our products have been approved by the U.S.
Department of the Air Force for use in the various tested applications and
configurations, and they will be supplied to the U.S. Department of the Air
Force through the major U.S. integrators.

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.

DreamBox

The
DreamBox is a state-of-the-art embedded hardware and software product which
integrates a number of CCTV related applications into one box. The system is
designed to be economical, as well as compact to save space, by avoiding the
use of a complicated cable installation and integration. It contains twelve
different applications, including a digital video and audio recording, video
and audio matrix switcher, outdoor and indoor video motion detection system, or
VMD, security management system, or SMS, and a transmission system.

The
DreamBox, is sold at a substantially lower price than the cost of the other
product applications if sold separately, a factor which positions DreamBox as
the leading security solution for all strategic facilities. Its target markets
include governmental, institutional and other sensitive facilities, such as
airports, train stations, seaports, prisons, casinos and hospitals, all of
which require the use of high quality CCTV applications.

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We
refer to the DreamBoxs target market as an add-on market for us, and believe
that this product is substantially broadening our target markets. As an
example, we entered the field of digital video recording, which is only one of
many DreamBox applications.

MTC-1500

The
MTC-1500 is an integrated thermal/daylight camera, specially designed for
strategic sites and secured areas such as borders, airports, seaports,
pipelines, refineries, communication centers, prisons, special operations and
municipal surveillance. The all-weather sealed unit provides high resolution
multi-sensor monitoring, utilizing an electro-optical video system which
combines a micro bolometric thermal camera for night vision and a CCD camera
for daylight use. This solution is able to detect human targets from more
then 1500 meters under variable lighting, temperature and weather conditions-
day or night, from sub-zero to very high temperatures- in rain, dust, sand or
fog.

MSS-1500

The
MSS-1500 is a rapidly-deployable, flexible, high-definition, surveillance
system for use by surveillance and security forces. It monitors situations and
detect intrusions and suspicious movements through high-quality optical and
thermal cameras having a continuous operating capability of over 4 hours. The
MSS-1500 is a stand-alone system consisting of a remote observation unit,
self-sufficient power supply and command center. The system may be set up and
be fully deployed in just 4 minutes. It is a vital resource in special
surveillance situations, including criminal investigation, crowd and riot
control and border patrol.

Security Management and Control 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 and Fortis, security management and control systems that
integrate 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, and support real-time decision making and wide area command and
control. These systems were developed to improve the response to real-time
security events by sharing video and geographical information between the
control center and security personnel acting in the field. Since their
introduction, we have sold our security management systems and provided turnkey
projects to several customers, including large international companies and
international airports.

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 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.

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

Integrated
Command and Control System

Fortis,
our fully integrated command and control system, supports real-time decision
making and wide-area command and control. Fortis reduces the period of time
from intruder detection to intruder engagement to a minimum. Fortis was
developed to improve the response to real-time security events by sharing video
and geographical information between the control center and security personnel
acting in the field.

The
system creates a unified and interactive intelligence picture - drawing data
from all sensors, while displaying the movement of security personnel in the
field and adding other relevant information, such as video from various sources,
auxiliary services and weather conditions. This combined picture, which is
continuously updated, is sent by the central command to all security personnel
in the command chain, and serves as a unified basis for operational planning
and allocation of tasks. Using advanced technology, Fortis provides the
security officer with a graphical command tool, which updates the location
details and video view of the alerting area, while simultaneously enabling a
constant watch over security personnel movements, thus optimizing the
operational response.

Fortiss
target markets include governmental, institutional and large sensitive
facilities, such as borders, airports, hospitals, power plants and water
sources, as well as large manufacturing facilities requiring real-time control
and protection.

Pipeline
Security Systems

As
of end of 2006, there were an estimated three million miles of unprotected oil
and gas pipelines worldwide. Although the need for securing these pipelines has
been strongly recognized by the oil and gas industry for years, and in spite of
increasing threats since the events of 9/11 and current instability in Iraq and
elsewhere in the Middle East, there was no effective solution for securing
buried pipes against damage caused by terror, sabotage, theft or other third
party threats. We have identified the demand and have implemented a technology
aimed at meeting this challenge. PipeGuard, our pipeline security system,
provides a solution for securing buried assets and infrastructure, including
oil and gas pipelines and buried communication lines such as fiber optic
cables.

PipeGuard
utilizes an innovative and unique technology to guard buried pipelines,
regardless of pipeline length, with the ability to detect potential attack and
alert authorities before potential harm or damage occurs. Its target market
includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies dealing with security and
environment.

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In
addition, in 2006 we started to market and sell PipeGuard to banks, to protect
them from underground intrusions. Following a long and thorough market study, we determined that one of
the major physical threats that banks worldwide currently face, are robberies
of valuables contained in safes located below ground by the digging of tunnels
beneath the banks building. PipeGuard has the ability to prevent underground
intrusions into bank buildings and break-ins into banks safes and other secure
areas. We identified this particular niche as one that carries a huge marketing
potential for our PipeGuard system.

PipeGuard
combines well proven sensors, geophones, with advanced edge of technology
recognition algorithm capabilities based on the analysis of seismic signals,
thus effectively filtering out false alarms. Using state of the art
communications, only predefined signals are transmitted to the control station.

PipeGuard
is suitable for all pipes or cables, from existing and operational pipelines,
to new pipelines under construction. The system can easily be integrated into a
full turnkey security solution, including perimeter protection, ground or air
patrol and others. By answering the challenge of securing pipelines, we offer a
total security solution for the oil and gas industry - from the oil field to
the refineries.

Personal
Emergency Location Systems

Our
products deliver high reliability personal portable duress alarm systems to
protect personnel in correctional facilities. These products identify
individuals in distress and can pinpoint the location of the distress signal
with an indoor-to-outdoor and floor-to-floor accuracy unmatched by any other
product.

Flash
Personal Emergency Alarm Systems, or Flash, and Flare Personal Emergency
Locating Systems, or Flare, use radio frequency technology to provide a one
touch emergency system that is so small it can be worn on a belt. The systems,
sold mainly to correctional facilities, consist of transmitters that send distress
signals to receivers mounted throughout the building. Receivers relay the
signal to a central location indicating someone requires assistance and their
location in the building. The systems employ automated testing procedures that
help to reduce maintenance costs. The hardware and software was developed and
researched in the U.S. and competes against infrared and ultrasonic
technologies.

Our
personal alarm system, or PAS, uses an ultrasonic based emergency notification
and communication system. The system, sold mainly to correctional facilities,
allows individuals moving throughout a facility to quickly indicate their exact
location in a crisis situation through a transmitter that is carried by them.

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 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 to provide commercial
real-time video monitoring security services.

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Smart
provides remote video verification services and remote video surveillance
services. Smart 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 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 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
central monitoring station is able to provide instantaneous security responses
across the U.S.

Marketing, Sales and Distribution

We
market products 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
2006, our U.S. subsidiary opened a new marketing and sales office in Herndon,
VA, adjacent to Washington Dulles Airport. This office is intended to serve the
growing needs of local, state and federal Homeland Security requirements. This
office focuses exclusively on providing a comprehensive security architecture
for perimeter applications, which is comprised of command and control, physical
security sensors, and intelligent video. The office hosts a solution center
demonstrating several of our advanced sensor solutions for intrusion detection,
pipeline infiltration, intelligent video surveillance, multi-sensor command and
control, as well as integration of our leading perimeter sensors, with advanced
intelligent video for real time decision support on the response to possible
intrusions.

In
addition we distribute perimeter intrusion detection systems to private
corporations. We attempt to initiate contacts 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 in the United Kingdom, Germany, Mexico, the United States, China,
Romania and Poland.

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
$253,000 in grants and as of December 31, 2006, our aggregate contingent
obligation amounted to $82,000. In the years ended December 31, 2004, 2005 and
2006, we did not pay any royalties.

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 have over 50 distributors who resell
these systems. We occasionally use agents to find suitable distributors and pay
finders fees to these agents for their services.

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For
the last three years we have distributed our taut wire detection systems in the
U.S. through our U.S. subsidiary, and an unaffiliated third party who was
granted a non-exclusive right to distribute such systems in the U.S. and in
Canada.

Security
Management and Control Systems, DreamBox and Turnkey Projects

Our
marketing efforts for our Security Management and Control Systems, DreamBox and
turnkey projects consists of direct contacts with potential customers. We offer
the MagNet, Fortis and DreamBox products primarily as part of comprehensive
turnkey project solutions or, at the customers preference, as stand-alone
products. We distribute our systems in the U.S. and Canada through our U.S. and
Canadian subsidiaries.

Pipeline
Security Systems

The
target markets for our pipeline security systems include oil and gas companies,
owners and operators of pipelines or communication cables and governmental
agencies engaged with security and environment issues.

Personal
Emergency Location Systems

We
market our personal emergency location systems directly to potential customers,
mainly correctional facilities in North America.

Video
Monitoring Services

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

The
following table shows the breakdown of our consolidated revenues for the
calendar years 2004, 2005 and 2006 by operating segment:

|                   |  |                         |        |      |                |        |  |   |        | 
|------------------ |  | ----------------------- | ------ | ---- | -------------- | ------ |  | - | ------ | 
|                   |  | Year Ended December 31, |       
|                   |  |                         |       
|                   |  | 2004                    |        | 2005 |                | 2006   | 
|                   |  |                         |        |      |                |        | 
|                   |  |                         |        |      | (In thousands) |        |  |   |       
|Perimeter products |  | $                       | 46,342 |      | $              | 40,143 |  | $ | 47,186 | 
|Projects           |  |                         | 11,375 |      |                | 17,970 |  |   | 16,167 | 
|Video monitoring   |  |                         | 2,060  |      |                | 2,897  |  |   | 3,358  | 
|Other              |  |                         | 691    |      |                | 272    |  |   | 247    | 
|                   |  |                         |        |      |                |        |  |   |        | 
|Total              |  | $                       | 60,468 |      | $              | 61,282 |  | $ | 66,958 | 
|                   |  |                         |        |      |                |        |  |   |        | 
|                   |  |                         |        |      |                |        |  |   |        | 

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Customers

The
following table shows the geographical breakdown of our consolidated revenues
for the calendar years 2004, 2005 and 2006:

|                             |  |                         |        |      |   |        |  |   |        | 
|---------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------ | 
|                             |  | Year Ended December 31, |       
|                             |  |                         |       
|                             |  | 2004                    |        | 2005 |   | 2006   | 
|                             |  |                         |        |      |   |        | 
|                             |  | (In thousands)          |       
|                             |  |                         |        |      |   |        |  |   |        | 
|Israel                       |  | $                       | 9,617  |      | $ | 19,309 |  | $ | 26,385 | 
|U.S.                         |  |                         | 17,871 |      |   | 13,185 |  |   | 11,904 | 
|Canada                       |  |                         | 4,068  |      |   | 8,759  |  |   | 5,630  | 
|Romania                      |  |                         | 9,521  |      |   | 6,244  |  |   | 1,531  | 
|Europe (excluding
  Romania) |  |                         | 9,150  |      |   | 3,691  |  |   | 8,262  | 
|Mexico                       |  |                         | 4,049  |      |   | 3,165  |  |   | 7,456  | 
|Others                       |  |                         | 6,192  |      |   | 6,929  |  |   | 5,790  | 
|                             |  |                         |        |      |   |        |  |   |        | 
|Total                        |  | $                       | 60,468 |      | $ | 61,282 |  | $ | 66,958 | 
|                             |  |                         |        |      |   |        |  |   |        | 

For
the years ended December 31, 2004, 2005 and 2006, revenues generated from
sales to the MOD and the IDF, accounted for 7.8%, 23.9% and 33.7%,
respectively, of our revenues. 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 generating similar revenues
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.

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
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 services, maintenance and support on an as
needed basis.

We
require distributors of our high-security perimeter systems to purchase a
demonstration kit that includes full-scale models of our perimeter products,
and to send technical personnel to Israel to 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 perimeter system is approximately ten years. Consequently, many
miles of perimeter systems need to be replaced each year.

During
2006, we derived approximately 9% 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 12-24 months of the delivery date of the
product.

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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 expenses during 2004, 2005 and 2006 were approximately
$5.1 million, $5.4 million and $5.5 million respectively, of which royalty
bearing grants from the Office of the Chief Scientist of the Israel Ministry of
Industry, Trade and Labor, or the OCS, and investment tax credits, constituted
approximately 8.0%, 3.0% and 2.9 %, of such expenses. 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:

| |   |                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | in Israel,
  we develop a wide range of products including our taut wire, mechanical
  vibration, video and high-end SMS systems and PipeGuard;                                                                  
| |   |                                                                                                                                                                                                                  
| |  | in
  California, we develop our microphonic fence sensors as well as our microwave
  detection, personal alarm and small/medium and control systems; and                                                         
| |   |                                                                                                                                                                                                                  
| |  | in Canada,
  we develop our leaky coax radar, triboelectric and fiber-optic fence sensors,
  electrostatic volumetric detection and medium to high-end control systems and
  personal emergency location systems.

Office
of the Chief Scientist of the Israel Ministry of Industry, Trade and Labor
(OCS)

We
have historically sought co-financing of our development projects from the
office of the Chief Scientist of the Israel Ministry of Industry, Track and
Labor or the OCS. We are obligated to pay royalties to the OCS, amounting to
3%-4.5% of revenues derived from sales of the products funded with these
grants, up to an amount equal to 100% of the grants received, linked to the
U.S. dollar. All grants received after January 1, 1999 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. We paid royalties amounting to $61,000, $83,000 and $79,000 in the
years ended December 31, 2004, 2005 and 2006, respectively. As of
December 31, 2006, our aggregate contingent obligation to the OCS amounted
to $1.7 million.

The
terms of these grants require that the manufacture of products developed with
these grants be performed in Israel and prohibit transferring technology
developed with 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.

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Backlog

As
of May 31, 2007, our backlog amounted to approximately $30 million of which
approximately $24.6 million is expected to be delivered by the end of 2007,
$3.3 million is expected to be delivered by the end of 2008 and $2.1 million is
expected to be delivered thereafter.

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 Yehud, Israel. See Property, Plants and
Equipment below.

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. We cannot assure you that we will continue to be
able to obtain such items from these suppliers on satisfactory terms.
Alternative sources of supply are available, and therefore, we are not
dependent upon these suppliers and subcontractors. We also 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. Nevertheless, 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.

Our
Canadian manufacturing operations are located at our facility in Carp, Ontario,
Canada and consist of design and development, assembly, final testing and
quality control. We use local subcontractors for producing and mounting our
printed circuit board assemblies.

Our
U.S. manufacturing operations are located at our facility in Fremont,
California and consist of development and design, assembly, quality control and
final testing. We use local subcontractors for producing and mounting our
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 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., RB-Tec Ltd., and GalDor
Ltd. in Israel, and Detektion Security Systems Inc., Herras, ,Remsdaq,
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, Siemens AG, Io-image and Bosch.

We
believe that our principal competitors for Dreambox systems are Nice Systems
Ltd., Verint Systems Inc. and DVTel Inc.

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

We
believe that our principal competitor for the Pipeguard system is an Australian
company, Future Fibre Technologies Pty. Ltd.

We
believe that our principal competitors for personal emergency location systems
are Actall Corp. and Visonic Networks.

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 approximately 46 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:

| |   |                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;
| |   |                                                                                                                                                                  
| |  | that any
  patents issued or licensed to us will not be challenged, invalidated or
  circumvented; or                                                            
| |   |                                                                                                                                                                  
| |  | 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
ability to compete effectively. We could become subject to litigation regarding
intellectual property rights, which could seriously harm our business.

We
have trademark rights associated with our use of Flash and Intelli-FLEX, and
rights obtained by trademark registration for Flare, Perimitrax, Panther,
Intelli-FIELD, Senstar, Senstar-Stellar and the Senstar-Stellar logo, Sentrax,
Omnitrax and Xfield.

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In
September 2006, we signed a non exclusive agreement with a third party for the
right to use certain intangible assets such as know-how and patents for the
production, sale and marketing of a perimeter security system based on
fiber-optics that is primarily used to protect marine sites. The contract
period is 2 years and we have the right to extend the contract for additional 5
years. The consideration for the license is $ 0.5 million, payable in 24
monthly installments. In addition, we will pay royalties based on a formula as
defined in the agreement.

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.

We,
or one of our subsidiaries, own 100% of the outstanding capital stock of our
subsidiaries in Canada, United States, Germany, the Netherlands, Mexico, United
Kingdom, Israel, Romania and Poland.

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

Our
principal facility in Israel is a two-story 2,533 square meter facility located
on a 4,352 square meter parcel in the Yehud Industrial Zone. Approximately 600
square meters are devoted to administrative, marketing and management functions
and approximately 700 square meters are used for engineering, system
integration and customer service. We use the remaining 1,233 square meters for
production management, production operations, including manufacturing,
assembly, testing, warehousing, shipping and receiving. 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.
In 2006, we leased a one-story 810 square meter facility located on a 1,820
square meter parcel in the Yehud Industrial Zone for $80,000 per year for use
in production and operations. The products that we manufacture at our
facilities in the Yehud Industrial Zone include our taut-wire intrusion
detection systems, our vibration detection systems, our video-motion detection
systems, MagNet, Fortis, DreamBox, PipeGuard, MTC-1500, MSS-1500 and other perimeter systems.

We
own 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. We use the remaining 18,000 square feet for
production operations, including cable manufacturing, assembly, testing,
warehousing, shipping and receiving. In December 2004, we purchased an
additional 182,516 square feet of vacant land adjacent to this property for
future expansion. We also lease 358,560 square feet of land near this facility,
for $2,500 per year for use as an outdoor sensor test and demonstration site
for our products. The products manufactured at this facility include the
Perimitrax/Panther 2000 and Omnitrex buried cable intrusion detection systems,
the Intelli-Field electro static detection system, the X-Field volumetric system
the Intelli-FLEX microphonic fence detection system, Flash and Flare, and
various perimeter monitoring and control systems.

25

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We
own a 20,000 square foot facility in Fremont, California. The products
manufactured at this facility include Intelli-Wave, various sensors, the PAS
personal alarm system and the MX control and monitoring center.

We
lease 2,793 square feet of office space in Herndon, Virginia at a cost of
$5,586 per month. The lease commenced on December 1, 2006 and will end on
November 30, 2010. We utilize this space, which houses marketing demo rooms, as
a sales office for our US subsidiary.

We
lease 4,894 square feet of office space in Cresskill, New Jersey at a cost of
$2,000 per month. The lease commenced on September 1, 2006 and terminates on
June 30, 2007. We utilized this space for the sales and marketing of our Dreambox
product.

Smart
leases 8,000 square feet of commercial space in College Point, New York at a
cost of $10,677 per month. The lease, which commenced on October 1, 2003 and
will terminate on September 30, 2008, is subject to a 3% annual rate increase.
The lease is subject to a five year renewal option.

We
also lease small offices in Germany, the United Kingdom, Mexico, Romania
and Poland for our sales and marketing entities.

We
believe that our facilities are suitable and adequate for our current
operations and the foreseeable future.

|         |                            
|-------- | ---------------------------
|ITEM 4A. | Unresolved
  Staff Comments

Not
applicable.

|        |                                               
|------- | ----------------------------------------------
|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.

Overview

We
develop, manufacture, market and sell complex computerized security systems.
Our systems are used in more than 75countries
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. Our
revenues are principally derived from:

| |   |                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a line of
  perimeter security systems, which automatically detect and locate intruders,
  identify the nature of intrusions and provide emergency notification;                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                   
| |  | turnkey
  projects based on security management, command and control systems, which
  integrate the management, control and display of various security systems
  into a single, real-time database and support real-time decision making and wide
  area command and control; and
| |   |                                                                                                                                                                                                                                                                                   
| |  | video
  monitoring services.                                                                                                                                                                                                                                                      

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Economic
and Other Factors

The
continued state of hostility between the State of Israel and the Palestinian
Authority has caused the State of Israel to increase its efforts to protect its
facilities and installations from unauthorized intrusions. In 2002, the Israeli
Government announced the construction of a perimeter system 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. We received orders having a value of approximately $19
million to install intrusion detection systems along approximately 150
kilometers. As of December 31, 2004, this project was completed. In 2003, the
Israeli Government resolved to extend the perimeter system and to continue
construction along most of the remaining parts of the seam-line. However,
following the UN resolution to refer the question of the legality of the
seam-line perimeter systems to the International Court of Justice in Hague, an
international opposition to the route selected by the Israeli government arose,
causing the Israeli Government to change and shorten the route of the seam-line
perimeter system. This opposition, as well as certain decisions of the Israeli
Supreme Court, caused a halt in the building of the seam-line fence during
2004. In 2005 the Israeli Government approved a new seam-line fence route and
the MOD renewed the work on the southern portion of the seam line. According to
recent reports in the Israeli press, the majority of the remaining segments of
the fence will be completed during 2007. Although we believe that we will
record revenues from the seam line project in 2007, we cannot assure you that
Israel will follow through with its decision to build the perimeter system
along the seam-line, or if such perimeter system is constructed or rebuilt, that
our products will be utilized.

| |                                                               |                                                                                                           
| | ------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------
| | Business
  Challenges/Areas of Focus                         
| |                                                              
| | Our primary
  business challenges and areas of focus include:
| |                                                              
| |                                                              | continuing
  the growth of revenues and profitability of our perimeter security system
  line of products;
| |                                                               |                                                                                                           
| |                                                              | enhancing
  the introduction and recognition of our new products into the markets;                        
| |                                                               |                                                                                                           
| |                                                              | penetrating
  into new markets and strengthening our presence in existing markets;                        
| |                                                               |                                                                                                           
| |                                                              | succeeding
  in selling our comprehensive turnkey solutions; and                                          
| |                                                               |                                                                                                           
| |                                                              | achieving
  operating profitability from our Smart subsidiary.                                            

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Discussion of Critical Accounting Policies

The
preparation of financial statements in conformity with U.S. GAAP 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 our 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 our revenues mainly from (1) installation of comprehensive security
systems for which revenues are generated from long-term fixed price contracts;
(2) sales of security products; and (3) services and maintenance, which are
performed either on a fixed-price basis or as time-and-materials based
contracts.

Revenues
from installation of comprehensive security systems are generated from
fixed-price contracts according to which the time between the signing of the
contract and the final customer acceptance is usually over one year. Such contracts
require significant customization for each customer specific needs and, as
such, revenues from these types of contracts are recognized using contract accounting
on a percentage of completion method. Accounting for long-term contracts using
the percentage-of-completion method stipulates that revenue and expense are
recognized throughout the life of the contract, even though the project is not
completed and the purchaser does not have possession of the project. Percentage
of completion is calculated based on the Input Method.

Project
costs include materials purchased to produce the system, related labor and
overhead expenses and subcontractors costs. The percentage to completion is
measured by monitoring costs and efforts devoted using records of actual costs
incurred to date in the project compared to the total estimated project
requirement, which corresponds to the costs related to earned revenues. The
amounts of revenues recognized are based on the total fees under the agreements
and the percentage to completion achieved. 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. Until
2006, we never experienced a material cancellation for one of our projects.

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
operations when they are reasonably determinable by management, on a cumulative
catch-up basis.

We
believes that the use of the percentage of completion method is appropriate as
we has the ability to make reasonably dependable estimates of the extent of
progress towards completion, contract revenues and contract costs. In addition,
contracts executed include provisions that clearly specify the enforceable
rights regarding services to be provided and received by the parties to the
contracts, the consideration to be exchanged and the manner and the terms of
settlement, including in cases of terminations for convenience. In all cases we
expect to perform our contractual obligations and our customers are expected to
satisfy their obligations under the contract.

Fees
are payable upon completion of agreed upon milestones and subject to customer
acceptance. Amounts of revenues recognized in advance of contractual billing,
are recorded as unbilled accounts receivable. The period between most instances
of advanced recognition of revenues and the customers billing generally ranges
between one to six months. At December 31, 2006, we recorded $5.4 million of
such unbilled receivables.

We
sell security products to customers according to customers orders without
installation work. The customers are not entitled to return the products.
Revenues from security product sales are recognized when delivery has occurred, persuasive evidence of an agreement
exists, the vendors fee is fixed or determinable, no further obligation exists
and collectibility is probable.

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Services
and maintenance are performed under either fixed-price based or time-and-materials based
contracts. Under fixed-price contracts, we agree to perform certain work for a fixed
price. Under time-and-materials contracts, we  are reimbursed for labor hours at negotiated hourly billing rates and for materials.
 Related revenues from such  service contracts are  recognized as those services are performed or over the term
of the related agreements provided that, an evidence of an arrangement has been obtained,
fees are fixed and determinable and collectibility is reasonably assured.

One
of our subsidiaries provides security video monitoring services. The majority
of its contracts are for a five year term and do not include terms that result
in the transfer of title of the equipment to the customer. Under the contracts
service is not dependent on specific equipment. The subsidiarys obligation is
related to the provision of monitoring services. The service contract does not
meet the definition of a lease and as such the subsidiary recognizes monthly
service fees over the term of the agreement.

Deferred
revenue includes unearned amounts under installation services, service
contracts and maintenance agreements.

Inventories

Inventories
are stated at the lower of cost or market value. We periodically evaluate the
quantities on hand relative to historical and projected sales volumes, current
and historical selling prices and contractual obligations to maintain certain
levels of parts. Based on these evaluations, inventory write-offs are provided
to cover risks arising from slow-moving items, discontinued products, excess
inventories, market prices lower than cost and adjusted revenue forecasts. Cost
is determined as follows:

| |   |                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Raw
  materials, parts and supplies - using the first-in, first-out method.                                                                       
| |   |                                                                                                                                                     
| |  | Work-in-progress
  and finished products - on the basis of direct manufacturing costs with the
  addition of allocable indirect manufacturing costs.

During 2004, 2005 and 2006, we recorded inventory write-offs from continued operations
in the amounts of $218,000, $420,000 and $760,000 respectively. Such write-offs
were included in cost of revenues.

During
2004, 2005 and 2006, we recorded inventory write-offs from discontinued
operations in the amount of $6,000, $87,000 and $62,000, respectively. Such
write-offs were included in our loss from discontinued operations, net.

Income taxes

We account for income taxes in accordance
with Statement of Financial Accounting Standard No. 109 Accounting for
Income Taxes. 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.

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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 our 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, 2006, we had a deferred tax asset of $2.3
million. We have total estimated available carryforward tax losses of $1.3
million to offset against future taxable income. Our subsidiaries in the United
States and the United Kingdom have estimated total available carry-forward tax
losses of $9.8 million and $0.9 million, respectively that may be used as an
offset against future taxable profit for 16-20 years and an indefinite period,
respectively. As of December 31, 2006, we recorded a full valuation allowance
of our subsidiaries tax assets due to the uncertainty of their future
realization.

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.

Goodwill

Goodwill
represents the excess of the costs over the net fair value of the assets of the
businesses acquired. Goodwill is tested for impairment at least annually or
between annual tests in certain circumstances, and written down when impaired,
rather than being amortized.

We
test goodwill impairment on acquisition and at least annually thereafter or
between annual tests in certain circumstances, we write down goodwill when
impaired, 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 flow.

Significant
estimates used in these methodologies include estimates of future cash flows,
future short-term and long-term growth rates and weighted average cost of
capital for each of the reportable units. During 2004, 2005 and 2006, no
impairment losses were identified.

As
of December 31, 2006, our goodwill amounted to $4.3 million which principally
relates to our perimeter security systems segment.

Impairment
of long lived assets

Our
Groups long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of a group of assets may not be recoverable. Recoverability of
a group of assets to be held and used is measured by a comparison of the
carrying amount of the group of assets to the future undiscounted cash flows
expected to be generated by the group of assets. If such group of assets is considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the group of assets exceeds their fair value.
During 2004, 2005 and 2006, no impairment losses were identified.

Functional
Currency and  Financial statements in U.S. dollars

We have determined that our reporting currency is the dollar. We have
determined that as  of October 1, 2006 our functional currency has changed
from the  U.S.  dollar to  NIS.
Translation adjustments resulting from translating our financial statements from the NIS
to the dollar are reported as a separate component in shareholders equity.

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Accordingly,
we had accumulated foreign currency translation income of approximately $2.4 million and
$2.4 million that was included as part of accumulated other comprehensive
income within our balance sheets at December 31, 2005 and 2006, respectively. During
2004, 2005 and 2006, foreign currency translation  adjustments,
net  of $1.1 million, $87,000 and  ($72,000),
respectively, were included under accumulated other comprehensive income. Had
we determined that the functional currency of our subsidiaries (not including our U.S.
subsidiaries) was the  U.S.  dollar, these gains would have increased
our income for each of the years presented.

The
first step in the translation process is to identify the functional currency
for each entity included in the financial statements. The accounts of each
entity are then remeasured in its functional currency. All transaction gains
and losses from the remeasurement of monetary balance sheet items are reflected
in the statement of operations as financial income or expenses, as appropriate.

After
the remeasurement process is complete the financial statements are translated
into the reporting currency, which is the dollar, using the current rate
method. Equity accounts are translated using historical exchange rates. All
other balance sheet accounts are translated using the exchange rates in effect
at the balance sheet date. Statement of operations amounts have been translated
using the average exchange rate for the year. The resulting translation
adjustments are reported as a component of shareholders equity in accumulated
other comprehensive income (loss).

Concentrations
of credit risk

Financial
instruments that are potentially subject to concentrations of credit risk consist
principally of cash and cash equivalents, short and long-term bank deposits, marketable
securities, unbilled accounts receivable, trade receivables, long-term trade
receivables and long-term loans.

Of our cash and cash equivalents,
marketable securities and short-term and long-term bank deposits at December 31, 2006,
$24.4 million is invested in major Israeli and U.S. banks, approximately $2.5
million is invested in other banks, mainly with Deutsche Bank, RBC Royal Bank and BBVA
Bancomer. Cash and cash equivalents in the United States 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.

Marketable
securities are comprised of investments in U.S. government debentures. We believe that
minimal credit risk exists with respect to these marketable securities.

The short term and long term trade receivables and the unbilled accounts receivable of our
company and our subsidiaries are derived from sales to large and solid organizations
located mainly in Israel, the United States, Canada, Mexico 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 and in accordance with an aging policy. In
certain circumstances, we may require letters of credit, other collateral or additional
guarantees. During the years ended December 31, 2004, 2005 and 2006, we recorded
$131,000, ($13,000) and $187,000 of expenses related to doubtful accounts,
respectively. As of December 31, 2006, the allowance for doubtful accounts
amounted to $493,000.

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The
loan granted to a third party is secured by a personal guarantee of the
beneficial owner. We believe that the loan is well secured, and accordingly,
minimal credit risk exists with respect to this loan.

We
have no significant off-balance sheet concentration of credit risks, such as
foreign exchange contracts or foreign hedging arrangements, except derivative
instruments, which are detailed below.

Derivative
instruments

We
recognize our derivative instruments as either assets or liabilities in our
statement of financial position at fair value. The accounting for changes in
the fair value (i.e., gains or losses) of a derivative instrument depends on
whether it has been designated and qualifies as part of a hedging relationship
and further, on the type of hedging relationship. For those derivative
instruments that are designated and qualify as hedging instruments, a company
must designate the hedging instrument, based upon the exposure being hedged.

To
protect against the change in the forecasted foreign currency cash flows of
certain sale arrangements resulting from changes in the exchange rate during
2004, 2005 and 2006, we entered into forward contracts, to hedge portions of
our forecasted revenue and unbilled accounts receivable denominated in Euros
and Polish Zlotys. We have designated the forward instruments as cash flow
hedges for accounting purposes.

For
derivative instruments designated as cash flow hedges (i.e., hedging the
exposure to variability in expected future cash flows that is attributable to a
particular risk), the effective portion of the gain or loss on the derivative
instrument is reported as a component of other comprehensive income and
reclassified into earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged transaction
affects earnings.

We
determined that it is probable that a sales arrangement in Polish Zlotys and the related forecasted
revenues and unbilled accounts receivable would not occur by the end of the
specified time period. Accordingly, changes in the fair value of the forward
contracts were recorded in financial expenses in the years ended December 31,
2005 and 2006.

On
October 1, 2006, we changed our functional currency from the dollar to NIS.
From the date of change in functional currency, the hedge of the revenues in
Euros is no longer effective. Changes in the fair value of the forward
contracts from October 1, 2006 were charged to financial expenses.

We recorded
$ 0, $ 110,000 and $ 915,000 as financial expenses related to forward contracts
transactions, in 2004, 2005 and 2006, respectively.

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Fair
value of financial instruments

The
following methods and assumptions were used by us and our subsidiaries in
estimating the fair value of our financial instruments:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The carrying
  amounts of cash and cash equivalents, marketable securities, short-term bank
  deposits, trade receivables, unbilled accounts receivable, short-term bank
  credit and trade payables approximate their fair value due to the short-term
  maturity of such instruments.                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The carrying
  amount of our long-term trade receivables and long-term bank deposits approximate their fair value. The fair value was estimated
  using discounted cash flows analyses, based on our investment rates for
  similar types of investment arrangements.                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The carrying
  amounts of our long-term bank debt are estimated by discounting the future
  cash flows using current interest rates for loans of similar terms and
  maturities. As of December 31, 2006, the fair value of our long-term
  borrowings was $5.3 million, compared to the carrying amount of $5.3 million.
  As of December 31, 2006, the fair value of our long-term borrowings was
  $ 8.2 million, compared to the carrying amount of $ 8.2 million.

Recent Accounting Pronouncements in the
United States

In
July 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income
Taxes an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies
the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the
financial statements. FIN 48 utilizes a two-step approach for evaluating tax
positions. Recognition (step one) occurs when an enterprise concludes that a
tax position, based solely on its technical merits, is more-likely-than-not to
be sustained upon examination. Measurement (step two) is only addressed if step
one has been satisfied (i.e., the position is more-likely-than-not to be
sustained). Under step two, the tax benefit is measured as the largest amount
of benefit, determined on a cumulative probability basis that is
more-likely-than-not to be realized upon ultimate settlement.

FIN 48
applies to all tax positions related to income taxes subject to the Financial
Accounting Standard Board Statement No. 109, Accounting for Income Taxes
(FAS 109). This includes tax positions considered to be routine as well as
those with a high degree of uncertainty.

FIN
48 has expanded disclosure requirements, which include a tabular roll forward
of the beginning and ending aggregate unrecognized tax benefits as well as
specific detail related to tax uncertainties for which it is reasonably
possible the amount of unrecognized tax benefit will significantly increase or
decrease within twelve months. These disclosures are required at each annual
reporting period unless a significant change occurs in an interim period.

33

---

---



FIN
48 is effective for fiscal years beginning after December 15, 2006. The
cumulative effect of applying FIN 48 will be reported as an adjustment to the
opening balance of retained earnings. We have evaluated the effect of
the adoption of FIN 48 on our financial statements, and expect that the
adoption of FIN 48 will have an effect of approximately $200,000 on our financial
statements.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS
No. 157). This statement provides a single definition of fair value, a
framework for measuring fair value, and expanded disclosures concerning fair
value. Previously, different definitions of fair value were contained in
various accounting pronouncements creating inconsistencies in measurement and
disclosures. SFAS No. 157 applies under those previously issued pronouncements
that prescribe fair value as the relevant measure of value, except SFAS
No. 123(R) and related interpretations. The statements does not apply to
accounting standard that require or permit measurement similar to fair value
but are not intended to measure fair value. This pronouncement is effective for
fiscal years beginning after November 15, 2007. We are currently evaluating the
impact of adopting SFAS 157.

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159), which permits
companies to choose to measure certain financial instruments and other items at
fair value that are not currently required to be measured at fair value. SFAS
No. 159 is effective for fiscal years beginning after November 15, 2007. We will adopt SFAS No. 159 no later than January 1, 2008. We have not yet
determined the effect that the adoption of SFAS No. 159 will have on our
consolidated financial statements.

|   |                   
|-- | ------------------
|A. | Operating Results.

Due
to the nature of our customers and products, our revenues are often generated
from a relatively small number of large orders. Consequently, individual orders
from individual customers can represent a substantial portion of our revenues 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
revenues and operating results may, therefore, vary substantially from period
to period. Consequently, we do not believe that our revenues and operating
results should necessarily be judged on a quarter-to-quarter comparative basis.

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

|                                        |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |     |  
|--------------------------------------- |  | ----------------------- | --- | ---- |  | ---- | - | ---- | --- | ---- |  | --- | - |  | --- | -
|                                        |  | Year Ended December 31, |    
|                                        |  |                         |    
|                                        |  | 2002                    |     | 2003 |  | 2004 |   | 2005 |     | 2006 | 
|                                        |  |                         |     |      |  |      |   |      |     |      | 
|Revenues                                |  |                         | 100 | %    |  | 100  | % |      | 100 | %    |  | 100 | % |  | 100 | %
|Cost
  of revenues                      |  |                         | 56  |      |  | 56   |   |      | 55  |      |  | 64  |   |  | 60  |  
|                                        |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |     |  
|Gross
  profit                          |  |                         | 44  |      |  | 44   |   |      | 45  |      |  | 36  |   |  | 40  |  
|                                        |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |     |  
|Operating
  expenses:                   |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |     |  
|Research and development, net           |  |                         | 7   |      |  | 8    |   |      | 8   |      |  | 9   |   |  | 8   |  
|Selling and marketing, net              |  |                         | 20  |      |  | 20   |   |      | 21  |      |  | 21  |   |  | 18  |  
|General and administrative              |  |                         | 11  |      |  | 9    |   |      | 9   |      |  | 10  |   |  | 10  |  
|Award granted by principal shareholders |  |                         | -   |      |  | -    |   |      | 2   |      |  | -   |   |  | -   |  
|                                        |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |     |  
|Operating
  income (loss)               |  |                         | 6   |      |  | 7    |   |      | 5   |      |  | (4  | ) |  | 4   |  
|Financial
  expenses, net               |  |                         | -   |      |  | (2   | ) |      | (1  | )    |  | (1  | ) |  | (1  | )
|                                        |  |                         |     |      |  |      |   |      |     |      |  |     |   |  |    
|Income (loss)
  before income taxes     |  |                         | 6   |      |  | 5    |   |      | 4   |      |  | (5  | ) |  | 3   |  

34

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|                                                  |  |                         |   |      |  |      |   |      |   |      |  |    |    |  |   |  
|------------------------------------------------- |  | ----------------------- | - | ---- |  | ---- | - | ---- | - | ---- |  | -- | -- |  | - | -
|                                                  |  | Year Ended December 31, |  
|                                                  |  |                         |  
|                                                  |  | 2002                    |   | 2003 |  | 2004 |   | 2005 |   | 2006 | 
|                                                  |  |                         |   |      |  |      |   |      |   |      | 
|Income
  taxes (tax benefit)                      |  |                         | 2 |      |  | 1    |   |      | 2 |      |  | -  |    |  | 2 |  
|                                                  |  |                         |   |      |  |      |   |      |   |      |  |    |    |  |   |  
|Income (loss)
  from continuing operations        |  |                         | 4 |      |  | 4    |   |      | 2 |      |  | (5 | )  |  | 1 |  
|Income
  (loss) from discontinued operations, net |  |                         | - |      |  | -    |   |      | - |      |  | -  |    |  | - |  
|                                                  |  |                         |   |      |  |      |   |      |   |      |  |    |    |  |   |  
|Net
  income (loss)                               |  |                         | 4 | %    |  | 4    | % |      | 2 | %    |  | (5 | )% |  | 1 | %
|                                                  |  |                         |   |      |  |      |   |      |   |      |  |    |    |  |   |  

Years ended December 31, 2005 and 2006

Revenues.
Revenues increased by 9.3% from $61.3 million in the year ended December 31,
2005 to $67 million in the year ended December 31, 2006. Revenues from
sales of perimeter systems increased from $40.1 million in 2005 to $47.2million in 2006, an increase of 17.5%,
mainly due to an order from the Israeli MOD to protect the Northern border of
Israel.Revenues from security
turnkey projects decreased by 10% from $18.0 million in 2005 to $16.2 million
in 2006. Based on our backlog as of May 31, 2007 of approximately $30 million,
our revenues in the first quarter of 2007 and our assessment of the market, we
anticipate that revenue in 2007 will increase compared to our revenues in 2006.

Cost
of revenues. Cost of revenues increased from $39.2
million in the year ended December 31, 2005 to $40.2 million in the year
ended December 31, 2006. Cost of revenues as a percentage of revenues was 63.9%
in 2005 as compared with 60.1% in 2006 as a result of the expenses we incurred
in 2005 in connection with a project in Eastern Europe that was cancelled. Due
to the uncertainty in preventing the forfeiture of a performance bank
guarantee, we included a provision of $1.4 million in respect of this guarantee
in our financial statements for the year ended December 31, 2005,. In view of
the settlement reached in the district court in Haifa, pursuant to which we
paid the customer approximately $700,000 of the disputed amount and the balance
will be repaid only if we are found liable for damages exceeding the amount
paid by us. In view of the above, we cancelled the balance of the provision
made in our financial statements in 2006.We anticipate that our cost of revenues as a percentage of
revenues will decrease in 2007.

Gross
profit. Gross profit increased from $22.1 million in
the year ended December 31, 2005 to $26.7 million for the year ended December
31, 2006, primarily as a result of the expenses we incurred in 2005 in
connection with the cancellation of the project Eastern Europe.

Research
and development expenses, net. Research and
development expenses, net for the year ended December 31, 2006 increased
to $5.4 million from $5.3million
for the year ended December 31, 2005, an increase of 2.1%, Research and
development expenses, net amounted to 8.6% of revenues in 2005, compared to
8.0% in 2006. Royalty bearing grants and investment tax credits totaled
$162,000 in both 2005 and 2006. We expect that our net research and development
expenditures as a percentage of revenues will remain the same in 2007.

Selling
and marketing expenses, net.Selling and marketing
expenses, decreased from $13.2 million for the year ended December 31,
2005 to $12.1 million for the year ended December 31, 2006, a decrease of
8.4%. The decrease in selling and marketing expenses in 2006 was primarily due
to a decrease in commissions paid in connection with our projects. Selling and
marketing expenses amounted to 21.5% and 18.0% of revenues in each of 2005 and 2006, respectively. We expect that our selling and
marketing
expenses as a percentage of revenues will remain at the same level in 2007.

35

---

---



General
and administrative expenses. General and
administrative expenses increased from $6.0 million for the year ended
December 31, 2005 to $6.5 million for the year ended December 31,
2006, an increase of 9.6%. The increase in general
and administrative expenses was due to $200,000 increase in expenses related to
doubtful accounts and due to expenses related to our compliance with the
requirements of the Sarbanes-Oxley Act. General
and administrative expenses amounted to 9.7% of revenues in 2005 compared to
9.8 % in 2006.We expect that our
general and administrative expenses will increase in 2007 due to the costs
associated with our compliance with the requirements of the Sarbanes-Oxley Act.

Financial
expenses, net. Financial expenses, net increased from $800,000 for the year ended
December 31, 2005 to $851,000 for the year ended December 31, 2006, an increase of
6.4%. We have determined that as of October 1, 2006 our functional currency changed
from the U.S. dollar to NIS. The U.S. dollar remains our reporting currency. This change resulted in
us incurring additional financial expenses in the fourth
quarter of 2006.

Income
taxes (tax benefit). We recorded a tax benefit of $23,000 for the year ended December 31,
2005, primarily as a result of the loss incurred in 2005, compared to income
tax expenses of $948,000 for the
year ended December 31, 2006. The effective
tax rate increased due to the fact that the income for taxes was based on the
utilization of the US dollar as our functional currency, therefore the decrease
in the income due to the change in our functional currency is not tax
deductible. In addition the deferred taxes include a valuation allowance
recorded in connection with our US operations.

Years ended December 31, 2004 and 2005

Revenues.
Revenues increased by 1.3% from $60.5 million in the year ended
December 31, 2004 to $61.3 million in the year ended December 31,
2005. Revenues from sales of perimeter systems were $46.3 million in 2004 as
compared with $40.1 million in 2005, a decrease of 13.4%. mainly due to decrease of sales in the U.S.
market. Revenues from security turnkey projects increased by 58.0% from
$11.4 in 2004 to $18.0 million in 2005 reflecting an increase in the number of projects in Canada.

Cost
of revenues. Cost of revenues increased from $33.2
million in the year ended December 31, 2004 to $39.2 million in the year ended
December 31, 2005. Cost of revenues as a percentage of revenues was 55.0%
in 2004 as compared with 63.9% in 2005 as a result of changes in the mix of our
revenues and the expenses we incurred in connection with a project in Eastern
Europe that was cancelled, including the provision of $1.4 million reserve
arising from customers demand for payment under a performance bank guarantee.

Gross
profit. Gross profit decreased from $27.2 million for
the year ended December 31, 2004 to $22.1 million in the year ended December
31, 2005, primarily as a result of expenses incurred in connection with the
cancelled project in Eastern Europe. Our expenses related to the project were
included in the cost of revenues. Due to the uncertainty, we did not recognize
any revenues from this project or reimbursement by the customer for these
expenses.

Research
and development expenses, net. Research and
development expenses, increased 12.4% from $4.7 million for the year ended
December 31, 2004 to $5.3 for the year ended December 31, 2005,
mainly due to our continued investment in the products that we launched in 2004
and in new products. Research and development expenses, net amounted to 7.7% in
2004 compared to 8.6% of revenues in 2005. Royalty bearing grants and
investment tax credits decreased from $405,000 in 2004 to $162,000 in 2005. We did not apply for any new royalty bearing
grants from the Chief Scientist in 2005.

36

---

---



Selling
and marketing expenses, net.Selling and marketing
expenses, increased from $12.5 million for the year ended December 31,
2004 to $13.2 million for the year ended December 31, 2005, an increase of
5.3%. The increase in selling and marketing expenses in 2005 was primarily due
to increased marketing and selling expenses for products first introduced in
2004, especially the DreamBox, and the increase in commissions paid
in connection with our projects. Selling and marketing expenses amounted to
20.7% and 21.5% of revenues in each of 2004 and 2005, respectively.

General
and administrative expenses. General and administrative
expenses increased from $5.8 million for the year ended December 31, 2004
to $6.0 million for the year ended December 31, 2005, an increase of
3.3%.. General and administrative expenses amounted to 9.5% of revenues in 2004
compared to 9.7% in 2005.The increase
in general and administrative
expenses was due to a $255,000 increase of in the amortization of deferred
stock compensation.

Financial
expenses, net. Financial expenses, net increased from
$762,000 for the year ended December 31, 2004 to $800,000 for the year
ended December 31, 2005.

Income
taxes (tax benefit). We recorded income taxes of $1.1 million for the year
ended December 31, 2004, as compared with a tax benefit of $23,000 for the year
ended December 31, 2005, primarily as a result of the loss we incurred in 2005.

37

---

---



Quarterly Results of Operations

The
following tables set forth certain unaudited quarterly financial information
for the two years ended December 31, 2006. The data has been prepared on a
basis consistent with our audited consolidated financial statements included
elsewhere in this annual report and include all necessary adjustments,
consisting only of normal recurring adjustments that we consider necessary for
a fair presentation. The operating results for any quarter are not necessarily
indicative of results for any future periods.

|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|------------------------------------------------------------------------------- |  | ------------------ | ------ | ---------- | - | ----------- | -- | -------- | ------ | ---------- | - | ---------- | -- | ----------- | ------ | ---------- | - | ------ | - | - | ------ | - | - | ------ | --
|                                                                                |  | Three months ended |       
|                                                                                |  |                    |       
|                                                                                |  | 2005               |        | 2006       |  
|                                                                                |  |                    |        |            |  
|                                                                                |  | Mar. 
  31,        |        | Jun.
  30, |   | Sept.
  30, |    | Dec. 31, |        | Mar.
  31, |   | Jun.
  30, |    | Sept.
  30, |        | Dec.
  31, |  
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |  
|Consolidated
  Statement of Income Data:                                        |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Revenues                                                                        |  | $                  | 13,726 |            | $ | 13,238      |    | $        | 15,761 |            | $ | 18,557     |    | $           | 13,472 |            | $ | 14,874 |   | $ | 16,160 |   | $ | 22,452 |   
|Cost
  of revenues                                                              |  |                    | 7,459  |            |   | 8,865       |    |          | 9,817  |            |   | 13,013     |    |             | 7,763  |            |   | 8,661  |   |   | 9,276  |   |   | 14,531 |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Gross
  profit                                                                  |  |                    | 6,267  |            |   | 4,373       |    |          | 5,944  |            |   | 5,544      |    |             | 5,709  |            |   | 6,213  |   |   | 6,884  |   |   | 7,921  |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Operating
  expenses:                                                           |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Research and development, net                                                   |  |                    | 1,156  |            |   | 1,276       |    |          | 1,337  |            |   | 1,496      |    |             | 1,200  |            |   | 1,450  |   |   | 1,152  |   |   | 1,576  |   
|Selling and marketing, net                                                      |  |                    | 2,726  |            |   | 3,340       |    |          | 3,503  |            |   | 3,611      |    |             | 2,583  |            |   | 2,702  |   |   | 2,830  |   |   | 3,964  |   
|General and administrative                                                      |  |                    | 1,413  |            |   | 1,438       |    |          | 1,367  |            |   | 1,743      |    |             | 1,447  |            |   | 1,416  |   |   | 1,674  |   |   | 1,996  |   
|Total
  operating expenses                                                      |  |                    | 5,295  |            |   | 6,054       |    |          | 6,207  |            |   | 6,850      |    |             | 5,230  |            |   | 5,568  |   |   | 5,656  |   |   | 7,536  |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Operating
  income (loss)                                                       |  |                    | 972    |            |   | (1,681      | )  |          | (263   | )          |   | (1,306     | )  |             | 479    |            |   | 645    |   |   | 1,228  |   |   | 385    |   
|Financial  expenses, net                                                        |  |                    | (329   | )          |   | (37         | )  |          | (119   | )          |   | (315       | )  |             | (154   | )          |   | (226   | ) |   | (260   | ) |   | (212   | ) 
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Income
  (loss) before income taxes                                             |  |                    | 643    |            |   | (1,718      | )  |          | (382   | )          |   | (1,621     | )  |             | 325    |            |   | 419    |   |   | 968    |   |   | 173    |   
|Income
  taxes (tax benefit)                                                    |  |                    | 318    |            |   | (170        | )  |          | (27    | )          |   | (144       | )  |             | 153    |            |   | 118    |   |   | 345    |   |   | 332    |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Income
  (loss) from continuing operations                                      |  |                    | 325    |            |   | (1,548      | )  |          | (355   | )          |   | (1,477     | )  |             | 172    |            |   | 301    |   |   | 623    |   |   | (159   | ) 
|Loss
  from discontinued operations, net                                        |  |                    | (31    | )          |   | (24         | )  |          | (21    | )          |   | (80        | )  |             | (23    | )          |   | (32    | ) |   | -      |   |   | (73    | ) 
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Net
  income (loss)                                                             |  |                    | 294    |            |   | (1,572      | )  |          | (376   | )          |   | (1,557     | )  |             | 149    |            |   | 269    |   |   | 623    |   |   | (231   | ) 
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Consolidated
  Statement of Income Data, expressed as a percentage of revenues: |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Revenues                                                                        |  |                    | 100.0  | %          |   | 100.0       | %  |          | 100.0  | %          |   | 100.0      | %  |             | 100.0  | %          |   | 100.0  | % |   | 100.0  | % |   | 100.0  | % 
|Cost
  of revenues                                                              |  |                    | 54.3   |            |   | 67.0        |    |          | 62.3   |            |   | 70.1       |    |             | 57.6   |            |   | 58.2   |   |   | 57.4   |   |   | 64.7   |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Gross
  profit                                                                  |  |                    | 45.7   |            |   | 33.0        |    |          | 37.7   |            |   | 29.9       |    |             | 42.4   |            |   | 41.8   |   |   | 42.6   |   |   | 35.3   |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Operating
  expenses:                                                           |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Research and development, net                                                   |  |                    | 8.4    |            |   | 9.6         |    |          | 8.5    |            |   | 8.0        |    |             | 8.9    |            |   | 9.8    |   |   | 7.1    |   |   | 7.0    |   
|Selling and marketing, net                                                      |  |                    | 19.9   |            |   | 25.2        |    |          | 22.2   |            |   | 19.5       |    |             | 19.2   |            |   | 18.2   |   |   | 17.5   |   |   | 17.7   |   
|General and administrative                                                      |  |                    | 10.3   |            |   | 10.9        |    |          | 8.7    |            |   | 9.4        |    |             | 10.7   |            |   | 9.5    |   |   | 10.4   |   |   | 8.9    |   
|Award granted by principal shareholders                                         |  |                    | -      |            |   | -           |    |          | -      |            |   | -          |    |             | -      |            |   | -      |   |   | -      |   |   | -      |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Total
  operating expenses                                                      |  |                    | 38.6   |            |   | 45.7        |    |          | 39.4   |            |   | 36.9       |    |             | 38.8   |            |   | 37.5   |   |   | 35.0   |   |   | 33.6   |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Operating
  income (loss)                                                       |  |                    | 7.1    |            |   | (12.7       | )  |          | (1.7   | )          |   | (7.0       | )  |             | 3.6    |            |   | 4.3    |   |   | 7.6    |   |   | 1.7    |   
|Financial  expenses, net                                                        |  |                    | (2.4   | )          |   | (0.3        | )  |          | (0.7   | )          |   | (1.7       | )  |             | (1.2   | )          |   | (1.5   | ) |   | (1.6   | ) |   | (0.9   | ) 
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Income
  (loss) before income taxes                                             |  |                    | 4.7    |            |   | (13.0       | )  |          | (2.4   | )          |   | (8.7       | )  |             | 2.4    |            |   | 2.8    |   |   | 6.0    |   |   | 0.8    |   
|                                                                               
|Income
  taxes (tax benefit)                                                    |  |                    | 2.3    |            |   | (1.3        | )  |          | (0.1   | )          |   | (0.7       | )  |             | 1.1    |            |   | 0.8    |   |   | 2.1    |   |   | 1.5    |   
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Income
  (loss) from continuing operations                                      |  |                    | 2.4    |            |   | (11.7       | )  |          | (2.3   | )          |   | (8.0       | )  |             | 1.3    |            |   | 2.0    |   |   | 3.9    |   |   | (0.7   | ) 
|Loss
  from discontinued operations, net                                        |  |                    | (0.2   | )          |   | (0.2        | )  |          | (0.1   | )          |   | (0.4       | )  |             | (0.2   | )          |   | (0.2   | ) |   | (0.0   | ) |   | (0.3   | ) 
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   
|Net
  income (loss)                                                             |  |                    | 2.2    | %          |   | (11.9       | )% |          | (2.4   | )%         |   | (8.4       | )% |             | 1.1    | %          |   | 1.8    | % |   | 3.9    | % |   | (1.0   | )%
|                                                                                |  |                    |        |            |   |             |    |          |        |            |   |            |    |             |        |            |   |        |   |   |        |   |   |        |   

Seasonality

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

| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | our
  customers are mainly budget-oriented organizations with lengthy decision
  processes which tend to mature late in the year; and
| |   |                                                                                                                                      
| |  | due to
  weather and other conditions, payments are often postponed from the first
  quarter to subsequent quarters.                 

See
also Item 3.D. Key InformationRisk Factors. Our revenues are dependent on
government procurement procedures and practices, and because we receive large
product orders from a relatively small number of customers, our revenues and
operating results are subject to substantial periodic variations.

38

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

Exchange
rate fluctuations between the NIS and the dollar, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparison of our results. In 2002 and 2005, the rate of devaluation of the NIS
against the dollar was 7.3% and 6.8% respectively, while in 2003, 2004 and
2006, the NIS appreciated in value in relation to the dollar by 7.6% and 1.6%
and 8.2% respectively. A portion of our expenses, primarily labor expenses, is
incurred in NIS and a part of our revenues are quoted in NIS. Additionally,
certain assets, as well as a portion of our liabilities, are denominated in
NIS. Our results may be adversely affected by the devaluation of the NIS in
relation to the dollar (or if such devaluation is on lagging basis), if our
revenues in NIS are higher than our expenses in NIS and/or the amount of our
assets in NIS are higher than our liabilities in NIS. Alternatively, our
results may be adversely affected by an appreciation of the NIS in relation to
the dollar (or if such appreciation is on a lagging basis), if the amount of
our expenses in NIS are higher than the amount of our revenues in NIS and/or
the amount of our liabilities in NIS are higher than our assets in NIS.

The
following table presents information about the rate of devaluation of the NIS
against the dollar:

|                          |  |                            |   |                          |      |                                                 |  |      |   | 
|------------------------- |  | -------------------------- | - | ------------------------ | ---- | ----------------------------------------------- |  | ---- | - | 
|Year ended
  December 31, |  | Israeli inflation
  rate % |   | NIS devaluation
  rate % |      | Israeli inflation adjusted 
  for devaluation % | 
|                          |  |                            |   |                          |      |                                                 | 
|2002                      |  | 6.5                        |   |                          | 7.3  |                                                 |  | (0.8 | ) | 
|2003                      |  | (1.9                       | ) |                          | (7.6 | )                                               |  | 5.7  |   | 
|2004                      |  | 1.2                        |   |                          | (1.6 | )                                               |  | 2.8  |   | 
|2005                      |  | 2.4                        |   |                          | 6.8  |                                                 |  | (4.4 | ) | 
|2006                      |  | (0.1                       | ) |                          | (8.2 | )                                               |  | 8.1  |   | 

Because exchange rates between the NIS and the dollar fluctuate continuously, exchange rate
fluctuations, particularly larger periodic devaluations, may have an impact on our
profitability and period-to-period comparisons of our results. We are also subject to
exchange rate fluctuations related to our activities in Canada. During the years
ended December 31, 2004 and 2005, foreign currency
fluctuations had an adverse impact on our results of operations, and our foreign exchange
losses, net were $120,000 and $145,000 respectively. During the year ended December 31,
2006, our foreign exchange gains, net were $276,000. We cannot assure you
that in the future our results of operations may not be materially adversely affected by
currency fluctuations.

To
protect against the change in the forecasted foreign currency cash flows of
certain sale arrangements resulting from changes in the exchange rate, during
2004, 2005 and 2006 we entered into forward contracts in order to hedge
portions of our forecasted revenue and unbilled accounts receivable denominated
in Euros and Polish Zlotys. We have designated the forward instruments as cash
flow hedges for accounting purposes.

For
derivative instruments designated as cash flow hedges (i.e., hedging the
exposure to variability in expected future cash flows that is attributable to a
particular risk), the effective portion of the gain or loss on the derivative
instrument is reported as a component of other comprehensive income and
reclassified into earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged transaction affects
earning.

We
determined that it is probable that our sales arrangement in Polish Zlotys and
the related forecasted revenues and accounts receivable will not occur by the
end of the specified time period. Accordingly, changes in the fair value of the
forward contracts were recorded in financial expenses in the years ended
December 31, 2005 and 2006.

On
October 1, 2006, we changed our functional currency from the dollar to NIS.
From the date of change in functional currency, the hedge of the revenues in
Euros is no longer effective. Changes in the fair value of the forward
contracts from October 1, 2006 were charged to financial expenses.

We
recorded $0, $110,000 and $915,000 as financial expenses related to forward
contracts transactions, in 2004, 2005 and 2006, respectively.

39

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Effective Corporate Tax Rate

Israeli
companies are generally subject to income tax on their worldwide taxable income. The applicable rate
for 2006 was 31%, which was reduced to 29% in 2007, and will be further reduced
to 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter. 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 years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 10% to 25% for an additional five to 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 years, rather than eight years. A foreign investors
company is defined in the Investment Law as a company in which more than 25% of
its shareholders are non-Israeli residents. Pursuant to the Investment Law, a
foreign investors company may enjoy benefits for a period of up to ten years,
(the actual length of the benefits period is graduated based on the percentage
of foreign ownership).

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, 2006, our subsidiaries in the United States and the United
Kingdom had estimated total available carry forward tax losses of $9.8 million and $0.9 million, respectively, to
offset against future taxable income for 16 to 20 years and an indefinite
period, respectively. A full valuation
allowance was recorded due to the uncertainty of the tax assets future
realization. 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.

We are
contesting a tax assessment for the years 2001-2004. In December 2006, the
Israeli Tax Authority issued a tax assessment, for the year 2001 in the amount
of approximately $850,000, including interest and linkage differences. We
submitted an objection to this assessment and are currently negotiating with
the Israeli Tax Authority with respect to the assessment. In our managements
opinion, we have good arguments against this assessment and believe that it is
more likely than not that we will not have to pay this amount, and therefore
did not record a provision regarding this assessment.

40

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|   |                                
|-- | -------------------------------
|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 received proceeds of $9.8
million from an initial public offering of 1,380,000 ordinary shares. In
February 1997, we raised $9.4 million from a follow-on offering of
2,085,000 ordinary shares. In April 2005, we raised an additional $14.9 million
from a follow-on offering of 1,700,000 ordinary shares. The proceeds from these
offerings together with cash flow from operations and our credit facilities are
our main sources of working capital.

Our working capital at December 31, 2005 was $35.5 million compared to
$39.7 million at December 31, 2006. Cash and cash equivalents amounted to $10.1 million at December 31, 2005 compared to $4.9 million at
December 31, 2006. Short-term and long-term bank deposits and marketable
securities amounted to $18.9 million at December 31, 2005 compared to
$22.1 million at December 31, 2006. Our cash and cash equivalents,
short and long-term bank deposits and marketable securities
are held mainly in U.S. dollars.

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 bank deposits,  marketable
securities  and our expected cash flow from operations in 2007 will be
sufficient to meet our planned cash requirements through 2007.

Cash Flows

The
following table summarizes our cash flows for the periods presented:

|                                                               |  |                          |        |      |   |         |   |   |        |  
|-------------------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------- | - | - | ------ | -
|                                                               |  | Years ended December 31, |       
|                                                               |  |                          |       
|                                                               |  | 2004                     |        | 2005 |   | 2006    |  
|                                                               |  |                          |        |      |   |         |  
|                                                               |  | (in thousands)           |       
|                                                               |  |                          |        |      |   |         |   |   |        |  
|Net
  cash provided by (used in) continuing operations         |  | $                        | 3,988  |      | $ | (3,820  | ) | $ | (1,560 | )
|Net
  cash provided by (used in) discontinued operations       |  |                          | (310   | )    |   | (319    | ) |   | 184    |  
|                                                               |  |                          |        |      |   |         |   |   |        |  
|Net
  cash provided by (used in) operating activities          |  |                          | 3,678  |      |   | (4,139  | ) |   | (1,376 | )
|Net
  cash provided by (used in) investing activities          |  |                          | 512    |      |   | (15,248 | ) |   | (5,248 | )
|Net
  cash provided by financing activities                    |  |                          | 3,096  |      |   | 17,269  |   |   | 1,688  |  
|Effect
  of exchange rate changes on cash and cash equivalents |  |                          | 289    |      |   | 253     |   |   | (255   | )
|Increase
  (decrease) in cash and cash equivalents             |  |                          | 7,575  |      |   | (1,865  | ) |   | (5,191 | )
|Cash
  and cash equivalents at the beginning of the year       |  |                          | 4,389  |      |   | 11,964  |   |   | 10,099 |  
|                                                               |  |                          |        |      |   |         |   |   |        |  
|Cash
  and cash equivalents at the end of the year             |  | $                        | 11,964 |      | $ | 10,099  |   | $ | 4,908  |  
|                                                               |  |                          |        |      |   |         |   |   |        |  

41

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Net
cash provided by operating activities was approximately $3.7 million in the
year ended December 31, 2004, compared to net cash used in operating activities
of approximately $4.1 million and $1.4 million in the years ended
December 31, 2005 and 2006, respectively. Net cash provided by operating
activities in the year ended December 31, 2004 was primarily attributable to
net income of $1.1 million, depreciation and amortization of $2.0 million, a
decrease in trade receivables of $4.0 million, an award to employees of $1.2
million that was paid by our principal shareholders and an increase in other
accounts payable and accrued expenses of $880,000, which was offset by a $4.1
million increase in unbilled accounts receivable a $2.0 million increase in
trade payables and a $552,000 increase in inventories. Net cash used in
operating activities in the year ended December 31, 2005 was primarily attributable
to a net loss of $3.2 million, an increase in trade receivables of $9.0
million, an increase in deferred income taxes of $1 million, an increase in
unbilled accounts receivable of $2.8 million and an increase in other accounts
receivable and prepaid expenses of $599,000, which was offset in part by an
increase in customer advances of $4.0 million, a $3.1 million increase in trade
payables, an increase in other accounts payable and accrued expenses of $2.2
million, depreciation and amortization of $2.0 million and a $1.7 million
decrease in inventories. Net cash used in operating activities in the year
ended December 31, 2006 was primarily attributable to an increase in trade
receivables of $4.0 million, an increase in inventories of $2.7 million, a return
of $2.8 million of customer advances and a decrease in trade payables of
$681,000, which was offset in part by net income of $810,000, depreciation and
amortization of $2.2 million, a decrease in unbilled accounts receivable of
$3.5 million, an increase in other accounts payable and accrued expenses of
$741,000 and a $533,000 decrease in other accounts receivable and prepaid
expenses.

Net
cash provided by investing activities was approximately $512,000 for the year
ended December 31, 2004, compared to net cash used in investing activities of
approximately $15.2 million and $5.2 million for the years ended December 31,
2005 and 2006, respectively. In the year ended December 31, 2004 we purchased
property and equipment of $4.9 million and purchased $3.0 million of long-term
bank deposits with the proceeds from the sale of $8.4 million of short-term
bank deposits. In the year ended December 31, 2005 we purchased $16.7 million
of short-term deposits and $2.7 million of property and equipment, which
purchases were offset by proceeds of $3.0 million from the redemption of
structured notes and $1.2 million from the sale of long-term deposits. In the
year ended December 31, 2006, we purchased property and equipment of $1.4
million, purchased $8.2 million of marketable securities, invested $622,000 in
a long term loan and purchased know how and patents for $323,000 with the
proceeds from the sale of marketable securities of $5.2 million.           In the year
ended December 31, 2004 net cash provided by financing activities of $3.1
million was primarily attributable to our incurring short-term bank credit of
$2.9 million and receiving $1.0 million from the exercise of employee stock
options, which was offset in part by the payment of $401,000 in dividends and
the principal payment of $365,000 in long-term bank loans. In the year ended
December 31, 2005, net cash provided by financing activities of $17.3 million
was primarily attributable to the receipt of net proceeds of $14.9 million from
the issuance of ordinary shares, $2.4 million from short-term bank credit and
$1.8 million from proceeds of long-term loans, which was offset in part by the
repayment of $1.7 million of long-term bank loans. In the year ended December
31, 2006, net cash provided by financing activities of $1.7 million was
primarily attributable to $3.2 million from proceeds of long-term loans and our
receipt of $163,000 from the exercise of employee stock options, which was
offset in part by $1.4 million from short-term bank credit and, the repayment
of $306,000 of long-term bank loans.

Capital
expenditures in 2004, 2005 and 2006 were principally for equipment for Smart,
computers, other machinery and equipment and
for expanding our facilities.We
estimate that our capital expenditures for 2007 will total approximately $2.7
million, of which approximately 67% will be spent in Israel, 27% in the U.S.
and Canada and 6 % in other countries. 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 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.

42

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---



Credit Lines and Other Debt

We
currently have credit lines with Bank Leumi Le-Israel B.M., or BLL, Union Bank
of Israel Ltd., or Union Bank, Mizrahi Tefahot Bank B.M., or MTB, and Bank
Hapoalim B.M. totaling $46.4 million in the aggregate. There are no
restrictions as to our use of any of these credit lines. We agreed not to
pledge any of our assets without the consent of these banks. In addition, in
connection with two of these credit lines, a fixed charge was placed on our physical
plant in Israel by each of BLL and Union Bank, each of which ranks pari-passu
with the other.

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

| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | A ratio of
  at least 40% of shareholders equity out of the consolidated total assets;
| |   |                                                                                        
| |  | Minimal
  annual consolidated net income in the amount of $1 million; and              
| |   |                                                                                        
| |  | The same
  shareholders maintain the core of control in our company.                   

As
of December 31, 2006, we were not in compliance with the requirement under our
credit lines with BLL, Union Bank and MTB that we have annual consolidated net
income of $1 million. BLL, Union Bank and MTB have agreed to waive such
requirement for 2006 and informed us that they will not require us to
immediately repay our outstanding indebtedness as a result of such
non-compliance. In addition BLL, Union Bank
and MTB have agreed to cancel their requirement that we maintain the above-
mentioned financial ratios and terms.

Our
loans under these credit lines are generally denominated in dollars. However,
we may occasionally have short-term NIS-denominated loans.

In
addition, our subsidiaries currently have credit lines with Bank Leumi USA, Royal
Bank of Canada and Deutsche Bank totaling $9.0 million in the aggregate.

Our
Canadian subsidiary, has undertaken to maintain general covenants and the
following financial ratios and terms in respect of its outstanding credit
lines:

| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | A quick
  ratio of not less than 1.25;                                            
| |   |                                                                                   
| |  | A ratio of
  total liabilities to tangible net worth of not greater than 0.75; and
| |   |                                                                                   
| |  | Tangible net
  worth of at least $9.0 million.                                    

As
of December 31, 2006, our Canadian subsidiary was in compliance with these
ratios and terms.

As
of December 31, 2006, we had approximately $18.8 million available under
our credit lines. In addition, our subsidiaries had approximately $2.5 million
available under their credit lines.

As
of December 31, 2006, our outstanding balances under our credit lines
consisted of:

| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | Short-term
  NIS-denominated loans of approximately $3.4 million, bearing an average
  interest at a rate of 5.85%;                 
| |   |                                                                                                                                     
| |  | Short-term
  dollar-denominated loans of approximately $13.6 million, bearing an average
  interest at a rate of 5.71%;             
| |   |                                                                                                                                     
| |  | Long-term
  dollar-denominated loans of approximately $3.0 million, bearing an average
  interest at a rate of 5.87%;               
| |   |                                                                                                                                     
| |  | Several bank
  performance and advance payment guarantees totaling approximately $6.5
  million, at an annual cost of 0.5%-1.0%; and
| |   |                                                                                                                                     
| |  | Forward
  contracts of approximately $1.1 million.                                                                                  

43

---

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As
of December 31, 2006, our subsidiaries had an aggregate of $5.2 million in
long-term loans as follows:

| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $2.5 million,
  bearing interest at a fixed annual rate of 6.06%. This loan is due in one
  installment in July 2008;                                                                                 
| |   |                                                                                                                                                                                                       
| |  | $500,000,
  bearing interest at an annual rate of 6.63% and collateralized by the assets
  of our US subsidiary, Magal Senstar Inc., or MSI. This loan is due in one
  installment in July 2008;      
| |   |                                                                                                                                                                                                       
| |  | $500,000,
  bearing interest at an annual rate of 5.8% and collateralized by MSIs
  assets. This loan is due in one installment in July 2008;                                                        
| |   |                                                                                                                                                                                                       
| |  | $674,000,
  bearing interest at a fixed rate of 5.45%. The loan is payable in 20
  quarterly installments of $47,200, commencing February 2006. We have
  guaranteed the full amount of this loan; and
| |   |                                                                                                                                                                                                       
| |  | $980,000,
  bearing interest at a fixed rate of 5.45%. The loan is due in one installment
  in November 2010. We have guaranteed the full amount of this loan.                                        

In
connection with the related loans listed immediately above, Bank Leumi USA
placed a $3.0 million fixed charge on our deposits with that bank.

The
two $500,000 promissory notes issued to Bank Leumi USA both contain covenants that
require us to maintain $1.0 million in deposits at all times, otherwise the
interest rate on the notes become the banks rate plus 0.25% until the minimum
deposit is maintained.

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

Government Grants

We
participate in programs sponsored by the Israeli Government for the support of
research and development activities. In the years ended December 31, 2004, 2005
and 2006, we obtained $228,000, $8,000 and $0, respectively, of royalty-bearing
grants from the OCS for certain of our research and development projects. We
are obligated to pay royalties to the OCS amounting to 3%-4.5% of revenues
derived from sales of the products funded with these grants, up to 100% of the
grants received, linked to the U.S. dollar. All 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 to the OCS amounted to $61,000, $83,000 and $79,000 in the years ended
December 31, 2004, 2005 and 2006, respectively.

As
of December 31, 2006, we had a contingent obligation to pay royalties of
approximately $1.7 million to
the OCS upon the successful sale of products developed using research and
development programs sponsored by the OCS.

The
Israeli Government, through the Fund for the Encouragement of Marketing
Activities, or the Fund, 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 $253,000 in grants from the
Fund and, during the years ended December 31, 2004, 2005 and 2006, we did not
pay any royalties. As of December 31, 2006, we had a remaining contingent
obligation to the Fund of $82,000.

44

---

---



Investment Tax Credit

Our Canadian
and U.S. subsidiaries are eligible for investment
tax credits on their research and development activities
and on certain current and capital expenditures. During the years ended December 31, 2004,
2005 and 2006, they recognized $177,000, $154,000 and
$162,000, respectively, of investment tax credits as a reduction of research and
development expenses. Our subsidiaries have available
investment tax credits of approximately $208,000 to reduce future
federal Canadian income taxes payable. These credits will expire in 2016
 through  2023. See also Item 4.B.
Information on the CompanyBusiness OverviewResearch and Development;
Royalties.

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

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 Operating
and Financial Review and ProspectsOperating Results and Operating and
Financial Review and ProspectsLiquidity and Financial Resources above.

|   |                                
|-- | -------------------------------
|E. | Off-Balance Sheet Arrangements.

At
December 31, 2006, we have guaranteed the advance payments and the performance
of our work to certain of our customers (usually government entities). Such
guarantees are required by contract for our performance during the installation
and operational period of projects throughout Israel and the rest of the world.
The guarantees for installation typically expire soon after certain milestones
are met and guarantees for operations typically expire proportionally over the
contract period. The maximum potential amount of future payments we could be
required to make under our guarantees at December 31, 2006 and March 31, 2007
were $6.5 million and $6.6 million, respectively. We have not recorded any
liability for such amounts, as we expect that our performance will be
acceptable and to date, no performance bank guarantees have been exercised
against us except with respect to our dispute relating to the project in
Eastern Europe. See Item 8.A -  Consolidated Statements and Other Financial
Information-Legal Proceedings.

|   |                                               
|-- | ----------------------------------------------
|F. | Tabular Disclosure of Contractual
Obligations.

The
following table summarizes our minimum contractual obligations and commercial
commitments as of December 31, 2006 and the effect we expect them to have on
our liquidity and cash flow in future periods.

|                                                                             |  |                                       |   |                     |  |           |  |           |       |                      |  |  |   |       |  |  |  |   |       |  |  |  |   |       |  | 
|---------------------------------------------------------------------------- |  | ------------------------------------- | - | ------------------- |  | --------- |  | --------- | ----- | -------------------- |  |  | - | ----- |  |  |  | - | ----- |  |  |  | - | ----- |  | 
|Contractual Obligations                                                      |  | Payments due by Period (in thousands)
|                                                                             |  |                                      
|                                                                             |  | Total                                 |   | less than 
  1 year |  | 1-2 Years |  | 3-5 Years |       | more than 
  5 years | 
|                                                                             |  |                                       |   |                     |  |           |  |           |       |                      | 
|Long-term bank debt obligations                                              |  |                                       | $ | 8,194               |  |           |  | $         | 795   |                      |  |  | $ | 5,116 |  |  |  | $ | 2,283 |  |  |  | $ | -     |  | 
|Capital (finance) lease obligations                                          |  |                                       |   | -                   |  |           |  |           | -     |                      |  |  |   | -     |  |  |  |   | -     |  |  |  |   | -     |  | 
|Operating lease obligations                                                  |  |                                       |   | 1,376               |  |           |  |           | 596   |                      |  |  |   | 712   |  |  |  |   | 68    |  |  |  |   | -     |  | 
|Purchase obligations                                                         |  |                                       |   | 300                 |  |           |  |           | 300   |                      |  |  |   | -     |  |  |  |   | -     |  |  |  |   | -     |  | 
|Other long-term liabilities reflected on
  our balance sheet under U.S. GAAP |  |                                       |   | 2,702               |  |           |  |           | -     |                      |  |  |   | 178   |  |  |  |   | -     |  |  |  |   | 2,524 |  | 
|Total                                                                        |  |                                       | $ | 12,572              |  |           |  | $         | 1,691 |                      |  |  | $ | 6,006 |  |  |  | $ | 2,351 |  |  |  | $ | 2,524 |  | 

45

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|        |                                           
|------- | ------------------------------------------
|ITEM 6. | Directors, Senior Management and Employees

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

Set
forth below are the name, age, principal position and a biographical
description of each of our directors and executive officers:

| |                          |  |    |     |                                                                   |          | 
| | ------------------------ |  | -- | --- | ----------------------------------------------------------------- | -------- | 
| | Name                     |  |    | Age |                                                                   | Position | 
| |                          |  |    |     |                                                                   |          | 
| | Jacob
  Even-Ezra        |  | 76 |     | Chairman of
  the Board                                          
| | Izhar Dekel              |  | 55 |     | President
  Chief Executive Officer and Director                 
| | Yehezkel
  Farber        |  | 66 |     | Vice
  President  Operations                                    
| | Zvi Dank                 |  | 57 |     | Vice
  President  Research and Development                      
| | Raya Asher               |  | 39 |     | Vice
  President  Finance, Chief Financial Officer and Secretary
| | Asaf
  Even-Ezra         |  | 41 |     | Vice
  President  Israel and West European Marketing            
| | Dany Pizen               |  | 55 |     | Vice
  President  East European and CIS Marketing               
| | Ofer Katz                |  | 58 |     | Vice
  President  Aviation Security                             
| | Raffi Netzer             |  | 44 |     | Vice
  President  Africa and Latin America Marketing            
| | Yehonatan
  Ben- Hamozeg |  | 48 |     | Vice
  President  Integrated Systems Development                
| | Nathan Kirsh             |  | 75 |     | Director                                                         
| | Jacob Nuss               |  | 59 |     | Director                                                         
| | Jacob Perry              |  | 63 |     | Director and
  Deputy Chairman of the Board                      
| | Zeev Livne               |  | 62 |     | Director                                                         
| | Shaul
  Kobrinsky        |  | 55 |     | Outside
  Director                                               
| | Anat Winner              |  | 48 |     | Outside
  Director                                               

Messrs.
Even-Ezra, Dekel, Kirsh, Nuss, Perry and Livne will serve as directors until
our 2007 Annual General Meeting of Shareholders. Mr. Kobrinsky and Mrs. Winner
will serve as outside directors pursuant to the provisions of the Israeli
Companies Law for three-year terms until our 2007 annual general meeting of
shareholders, following which their service may be renewed for only one
additional three-year term.

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 these
relationships, there are no other family relationships among our directors and
senior executives.

Jacob
Even-Ezra has served as our chairman of the board
since 1984. From 1984 until 2006 he also served as chief executive officer
since, and from 1987 until 1990 he served as our president as well. 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 holds a B.Sc. in Electrical
Engineering from Israel Institute of Technology, or the Technion. Recently, Mr.
Even Ezra notified our board that he intends to retire from his position as
Chairman not later than December 31, 2007, but will continue to serve as a
member of our board. Upon Mr. Evan Ezras retirement, Mr. Jacob Perry will
become the Chairman of the Board.

Izhar
Dekel has served as our president since 1990, as our
chief executive officer since 2006 and as a director since 1993. Mr. Dekel
served as our finance manager from 1984 to 1990. Mr. Dekel holds an M.B.A. and
a B.A. in Economics and International Relations from the Hebrew University of
Jerusalem.

46

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

Zvi
Dank has served as our vice president - research and
development since 1984. Before joining us, Mr. Dank worked as an
electronic engineer in the electronics division of IAI. Mr. Dank holds a B.Sc.
in Electrical Engineering from the Technion.

Raya
Asher has served as our vice president - finance,
chief financial officer and secretary since 1998. Prior to joining us,
Ms. Asher served as a senior audit manager with Kost Levary and Forer,
Certified Public Accountants in Israel, the predecessor of our auditors, Kost
Forer Gabbay & Kasierer, a Member of Ernst & Young Global.
Ms. Asher holds an M.B.A. in Business and a B.A. in Accounting and
Economics from Tel Aviv University.

Asaf
Even-Ezra joined us in 1995 and has served as our vice
president - Israel and West European marketing since 1998. Mr. Even-Ezra
also heads our video motion detection division. Mr. Even Ezra holds an M.B.A.
and a B.A. in Business from the New York Institute of Technology.

Dany
Pizen has served as our vice president - East European
and CIS marketing since 1995. 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 and retired as a Lieutenant Colonel. Mr. Pizen
holds a B.A. in Social Science from Bar Ilan University.

Ofer
Katz has served as our vice president - aviation
security since 1995. Prior to that and since 1984 he served in our software and
computer development department as manager of our production line and in
operations and special projects.

Rafi
Nezer has served as our vice president - Africa and
Latin America marketing since 2004. Before joining us and since 1999, Mr. Nezer
acted as director of marketing for Rada Electronic Industries Ltd. Mr. Nezer
holds an M.B.A. in Business Administration from INSEAD and an L.L.B. from the
Tel Aviv University.

Yehonatan
Ben- Hamozeghas served as our vice president 
Integrated Systems Development since 2002. Before joining us, Mr. Ben
Hamozeg served in the IDF for 24 years and retired as a Colonel. Mr. Ben
Hamozeg holds an M.B.A. in Business Management and a B.A. in Economics and
Statistics from Haifa University.

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 100% of the ordinary
shares of our company that are held by Mira Mag Inc. Mr. Kirsh holds a B.S. in
Commerce from the University of Witwatersrand, Johannesburg.

Jacob
Nuss has served as a director since 1993.
Mr. Nuss currently serves as the vice president - internal auditing of
IAI, and served as IAIs deputy vice president - internal auditing from 1999 to
2003. 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. Mr. Nuss has served in various
financial management capacities at IAI since 1975. Mr. Nuss holds an M.B.A. in
Business from the Tel Aviv University and a B.A. in Economics and Business
Management from Bar Ilan University. Mr. Nuss holds a certificate in internal
auditing.

47

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Jacob
Perry has served as a director since December 2002,
and as deputy chairman of the board since 2006. Upon the retirement of Mr.
Jacob Even Ezra, Mr. Perry shall replace him as the Chairman of our Board. 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 with 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 management of many public organizations.
Mr. Perry is also a chairman of the board of directors of various companies,
including Mizrahi Tefahot Bank B.M., B- Contact Ltd., a content company for
cellular services, Pinpoint, Inc., a blank check company traded in the U.S.,
Allo Telecom and Keren Mor. Mr. Perry also serves as a director of Phytech
Technologies. Mr. Perry holds an A.M.P. from Harvard Business School and a B.A.
in Oriental Studies and History of the Jewish People from Tel-Aviv University.

Zeev
Livne has
served as a director since July 2004. Mr. Livne has served as the chairman of Livne Strategic
Consultants LTD.since 2001.Mr. Livne served 39 years with the
IDF until 2001. During his long military career with the IDF, Mr. Livne served
as the Defense Attaché to the U.S. and
Canada from 1997 to 2001, Military Secretary to the Prime Minister of
Israel from 1996 to 1997 and Ground Force Commander from 1994 to 1996. From
1992 to 1994 Mr. Livne established the IDF Home Front Command and served as its
first Commander. Mr. Livne serves on the board of directors of PAZKAR, a
private Israeli company. Mr. Livne holds a B.A. in History from the Tel Aviv
University, and an M.A. in Geography from the University of Haifa.

Shaul
Kobrinsky has served as an outside director
since July 2004. Mr. Kobrinsky has served as the President and Chief Executive Officer of Urdan
Industries Ltd., an investment and holding company since 1997. Since 2003 Mr.
Kobrinsky has served as senior managing director of Alagem Capital Group (a
Beverly Hills based investment group). From 1989 to 1997, Mr. Kobrinsky served
as chief executive officer of
Cargal Ltd., an Israeli company that manufactures corrugates. Previously, and
since 1984, Mr. Kobrinsky served as deputy managing director of Clal Industries
Ltd., a holding and investment company. Mr. Kobrinsky serves as an outside
director of Scope Metal Trading Ltd. Mr.Kobrinsky
holds a B.A. in Economics from Tel Aviv University.

Anat Winner has served as an outside director since July 2004. Mrs. Winner has been a
business advisor since 2003. Mrs. Winner served from October 2001 to May
2003 as Chief Executive Officer and Chief Financial Officer of Israel News
Ltd. From 1999 to October 2001, Mrs. Winner served as Chief Financial Officer of DBS
Satellite Services (1998) Ltd. (YES), an Israeli company that is engaged in setting up and
operating DBS television systems. From 1998 to 2000 Mrs. Winner served as
an outside Director and chairman of the audit committee of Memsar Ltd. Previously, from
1995 to 1998,  Mrs. Winner served as chief financial officer of Eurocom
Cellular Communications Ltd., an Israeli company that is engaged in importing and
marketing cellular phones.  From 1989 to 1995, Mrs. Winner served in various finance
positions, including Chief Financial Officer of Hazera [the Seed company] (1939) Ltd. From 1984 to 1989 Mrs. Winner served as a senior audit manager with
Ronel Stetner & Co., Certified Public Accountants in Israel. Mrs.
Winner also serves as a director of Internet Gold-Golden Lines Ltd. Mrs. Winner holds a
B.A. degree in Accounting and Economics from Haifa University and has been a certified
public accountant since 1987.

Chaim
Porat, our VP marketing for Far East and Australia, retired in May 2007.

48

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

During
the fiscal year ended December 31, 2006, we paid aggregate compensation to
all of our officers and directors as a group (consisting then of 16 persons) of
approximately $1.4 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.

Our
outside directors as well as directors who are not officers of our company or
of any entity that beneficially owns 5% or more of our ordinary shares, receive
an annual fee of $5,600 and an additional fee of $300 for each board or
committee meeting that they attend.

We
follow Israeli law and practice, instead of the NASDAQ Marketplace
requirements, regarding the compensation of our chief executive office and
other executive officers. Under the Israeli Companies Law, arrangements as to
compensation of office holders who are not directors require approval by the
board of directors, provided that they are not deemed extraordinary
transactions. Any compensation arrangement with an office holder who is not a
director that is deemed an extraordinary transaction, the exemption of such
office holder from liability, the insurance of such office holder and the
indemnification of such office holder, or an undertaking to indemnify such
office holder, require both board of directors and audit committee approval.
The compensation, exemption, indemnification and insurance of office holders
who are directors must be approved by our audit committee, board of directors
and shareholders. If the office holder is a controlling shareholder or a
relative of a controlling shareholder, any extraordinary transaction,
compensation, exemption, indemnification and insurance of the office holder
must be approved by our audit committee, board of directors and shareholders, supported
by the vote of at least one-third of the shares of the non-controlling
shareholders voting on the matter, or provided that the total number of shares
held by non-controlling shareholders that voted against the proposal did not
exceed one percent of all of the voting rights in the company. See below in
this Item 6.C. Directors, Senior Management and Employees - Board Practices -
NASDAQ Exemptions for Foreign Private Issuers.

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

During
2006, we did not grant any options to our directors or executive officers.
During 2005, we granted options for the purchase of total of 62,300 ordinary
shares to certain of our directors and executive officers.

|   |                 
|-- | ----------------
|C. | Board Practices.

Introduction

According
to the Israeli Companies Law and our Articles of Association, the management of
our business is vested in our board of directors. The board of directors may
exercise all powers and may take all actions that are not specifically granted
to our shareholders. Our executive officers are responsible for our day-to-day
management. The executive officers have individual responsibilities established
by our chief executive officer and board of directors. Executive officers are
appointed by and serve at the discretion of the board of directors, subject to
any applicable agreements.

49

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Election of Directors

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. Our Board of Directors is currently composed of eight
directors.

Our
directors (except the outside directors as detailed below), are elected by our
shareholders at our annual general meeting and hold office until the next
annual general meeting. All the members of our board of directors (except the
outside directors as detailed below), may be reelected upon completion of their
term of office. 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. All of our
current directors, except the outside directors, were elected by our
shareholders at our annual general meeting of shareholders of September 2006.
Our outside directors were elected by our shareholders at our annual general
meeting of shareholders of July 2004. Our outside directors will hold office
until our 2007 annual general meeting of shareholders, following which their
service may be renewed for only one additional three-year term.

Under
the Israeli Companies Law, our board of directors is required to determine the
minimum number of directors who must have accounting and financial expertise,
as such term is defined in regulations promulgated under the Israeli Companies
Law. Our Board of Directors has determined that our Board of Directors will
include at least one director who has accounting and financial expertise, within
the meaning of the regulations promulgated under the Israeli Companies Law. Our
Board of Directors has further determined that Ms. Anat Winner has the
requisite accounting and financial expertise.

We
do not follow the requirements of the NASDAQ Marketplace Rules with regard to
the nomination process of directors, and instead, we follow Israeli law and
practice, in accordance with which our directors are recommended by our board
of directors for election by our shareholders. See below in this Item 6.C.
Directors, Senior Management and Employees - Board Practices - NASDAQ
Exemptions for Foreign Private Issuers.

Outside and Independent Directors

Outside
Directors. The Israeli Companies Law requires Israeli
companies with shares that have been offered to the public in or outside of
Israel to appoint at least two outside directors. Outside directors must be
Israeli residents who are qualified to be appointed as directors, unless the
companys shares have been offered to the public outside of Israel or have been
listed on a stock exchange outside of Israel. The Israeli Companies Law
provides that a person may not be appointed as an outside director if the
person, or the persons relative, partner, employer or an entity under that
persons control, has or had during the two years preceding the date of
appointment any affiliation with the company, or any entity controlling,
controlled by or under common control with the company. The term relative
means a spouse, sibling, parent, grandparent, child or child of spouse or
spouse of any of the above. The term affiliation includes an employment
relationship, a business or professional relationship maintained on a regular
basis, control and service as an office holder, excluding service as an outside
director of a company that is offering its shares to the public for the first
time.

In
addition, no person may serve as an outside director if the persons position
or other activities create, or may create, a conflict of interest with the
persons responsibilities as director or may otherwise interfere with the
persons ability to serve as director. If, at the time an outside director is
appointed, all current members of the board of directors are of the same
gender, then that outside director must be of the other gender. A director of
one company may not be appointed as an outside director of another company if a
director of the other company is acting as an outside director of the first
company at such time.

50

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As
of 2006, at least one of the outside directors elected must have accounting
and financial expertise and any other outside director must have accounting
and financial expertise or professional qualification, as such terms are
defined by regulations promulgated under the Israeli Companies Law. However,
Israeli companies listed on certain stock exchanges outside Israel, including
The NASDAQ Global Market, are not required to appoint an outside director with
accounting and financial expertise if a director with accounting and
financial expertise who qualifies as an independent director for purposes of
audit committee membership under the laws of the foreign country in which the
stock exchange is located serves on its board of directors. All of the outside
directors of such a company must have professional qualification.

The
outside directors are elected by shareholders at a general meeting. The
shareholders voting in favor of their election must include at least one-third
of the shares of the non-controlling shareholders of the company who voted on
the matter. This minority approval requirement need not be met if the total
shareholdings of those non-controlling shareholders who vote against their
election represent 1% or less of all of the voting rights in the company.

In
general, outside directors serve for a three-year term and may be reelected to
one additional three-year term. However, Israeli companies listed on certain
stock exchanges outside Israel, including The NASDAQ Global Market, may appoint
an outside director for additional terms of not more than three years subject
to certain conditions. Such conditions include the determination by the audit
committee and board of directors, that in view of the directors professional
expertise and special contribution to the companys board of directors and its
committees, the appointment of the outside director for an additional term is
in the best interest of the company. Outside directors can be removed from
office only by the same special percentage of shareholders that can elect them,
or by a court, and then only if the outside directors cease to meet the
statutory qualifications with respect to their appointment or if they violate
their duty of loyalty to the company.

Any
committee of the board of directors that is authorized to exercise powers
vested in the board of directors must include at least one outside director and
the audit committee must include all the outside directors. All outside
directors are members of the audit committee of our company. An outside
director is entitled to compensation as provided in regulations adopted under
the Israeli Companies Law and is otherwise prohibited from receiving any other
compensation, directly or indirectly, in connection with such service.

Independent
Directors. In general, NASDAQ Marketplace Rules
require that the board of directors of a NASDAQ-listed company have a majority
of independent directors and its audit committee must have at least three
members and be comprised only of independent directors, each of whom satisfies
the respective independence requirements of NASDAQ and the Securities and
Exchange Commission. However, foreign private issuers, such as our company, may
follow certain home country corporate governance practices instead of certain
requirements of the NASDAQ Marketplace Rules. On June 27, 2006, we provided
NASDAQ with a notice of non-compliance with respect to the requirement to
maintain a majority of independent directors, as defined under NASDAQ Marketplace
Rules. Instead, we follow Israeli law and practice which requires that we
appoint at least two outside directors, within the meaning of the Israeli
Companies Law, to our board of directors. (See below in this Item 6C.
Directors, Senior Management and Employees - Board Practices - NASDAQ
Marketplace Rules and Home Country Practices.) In addition, in accordance with
the rules of the Securities and Exchange Commission and NASDAQ, we have the
mandated three independent directors, as defined by the rules of the Securities
and Exchange Commission and NASDAQ, on our audit committee.

51

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Our
Board of Directors has determined that Ms. Winner and Mr. Kobrinsky qualify
both as independent directors under the requirements of the Securities and
Exchange Commission and NASDAQ and as outside directors under the requirements
of the Israeli Companies Law. Our Board of Directors has further determined
that Messrs. Nuss and Livne qualify as independent directors under the
recruitments of the Securities and Exchange Commission and NASDAQ requirements.

Audit Committee

Our
audit committee, which was established in accordance with Section 114 of the
Israeli Companies Law and Section 3(a)(58)(A) of the Securities Exchange Act of
1934, assists our board of directors in overseeing the accounting and financial
reporting processes of our company and audits of our financial statements,
including the integrity of our financial statements, compliance with legal and
regulatory requirements, our independent public accountants qualifications and
independence, the performance of our internal audit function and independent
public accountants, finding any defects in the business management of our
company for which purpose the audit committee may consult with our independent
auditors and internal auditor, proposing to the board of directors ways to
correct such defects, and such other duties as may be directed by our board of
directors.

The
responsibilities of the audit committee also include approving related-party
transactions as required by law. Under Israeli law an audit committee may not
approve an action or a transaction with a controlling shareholder, or with an
office holder, unless at the time of approval two outside directors are serving
as members of the audit committee and at least one of the outside directors was
present at the meeting in which an approval was granted.

Our
audit committee consists of three board members who satisfy the respective
independence requirements of the Securities and Exchange Commission, NASDAQ
and Israeli Law for audit committee members. Our audit committee is currently
composed of Mrs. Anat Winner and Messrs. Shaul Kobrinsky and Jacob Nuss. Our
Board of Directors has determined that Ms. Anat Winner has financial
expertise within the meaning of the Israeli Companies Law. The audit committee
meets at least once each quarter. Our audit committee charter is available on
our website at www.magal-ssl.com.

Our
Board has appointed a special compensation committee composed of Mr. Kobrinsky
and Mr. Nuss to review, discuss and make recommendations to the Audit Committee
regarding the terms of retirement of Mr. Even Ezra from his position as the
executive Chairman of the Board.

Internal Auditor

Under
the Israeli Companies Law, the board of directors of a public company must
appoint an internal auditor nominated 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 Israeli 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. Mr. Daniel Spira, CPA (Isr.) is our internal auditor.

52

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Directors Service Contracts

We
do not have any service contracts with our directors. There are no arrangements
or understandings between us and any of our subsidiaries, on the one hand, and
any of our directors, on the other hand, providing for benefits upon
termination of their employment or service as directors of our company or any
of our subsidiaries.

Approval of Related-Party Transactions under
Israeli Law

The
Israeli Companies Law codifies the fiduciary duties that office holders,
including directors and executive officers, owe to a company. An office
holder is defined in the Israeli Companies Law as a director, general manager,
chief business manager, deputy general manager, vice general manager, or any
person filling any of these positions in a company even if he or she holds a
different title, and also includes any other manager directly subordinate to
the general manager. An office holders fiduciary duties consist of a duty of
care and a duty of loyalty. An office holder must act at a level of care that a
reasonable office holder in the same position would employ under the same
circumstances. This includes the duty to utilize reasonable means to obtain:

| |   |                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | information regarding the
  business feasibility of an action brought for his or her approval or
  performed by him or her by virtue of his or her position; and
| |   |                                                                                                                                                                 
| |  | all other important
  information pertaining to these actions.                                                                                                  

The
duty of loyalty requires that an office holder act in good faith and for the
benefit of the company, including the duty to:

| |   |                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | avoid any conflict of interest
  between the office holders position in the company and any other position he
  holds or his personal affairs;                                  
| |   |                                                                                                                                                                                  
| |  | avoid any competition with the
  companys business;                                                                                                                             
| |   |                                                                                                                                                                                  
| |  | avoid exploiting any business
  opportunity of the company in order to obtain benefit for the office holder
  or any other person; and                                           
| |   |                                                                                                                                                                                  
| |  | disclose to the company any
  information or documents relating to the companys affairs which the office
  holder received by virtue of his or her position as an office holder.

The
Israeli Companies Law regulates the approval procedures for transaction of a
company with its controlling shareholders or transaction in which office
holders or the controlling shareholders or their relative have personal
interest. For the purpose of these requirements a controlling shareholder is
defined as a shareholder that holds either solely or in concert with others at
least 25% of the issued share capital of the company unless another shareholder
holds more than 50% of the issued share capital. The holdings of two or more
shareholders, each having personal interest in the approval of the same
transaction shall be aggregated for this purpose.

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Under
the Israeli Companies Law, transactions of a company with an office holder and
transactions of a company with another entity in which an office holder has a
personal interest and which are not extraordinary transactions, must be
approved by the board of directors or as otherwise provided for in a companys
articles of association. An extraordinary transaction is a transaction other
than in the ordinary course of business, other than on market terms, or likely
to have a material impact on the companys profitability, assets or
liabilities. Extraordinary transactions with an office holder that is not a
director and transactions that involve the grant of an exemption, insurance,
indemnification or an undertaking to indemnify an office holder that is not a
director must be approved by the audit committee and the board of directors.
Extraordinary transactions with a director and transactions involving the
conclusion of a contract by a company with a director as to the terms of his
office, including the grant of an exemption, insurance, indemnification or an
undertaking to indemnify, or the conclusion of a contract by a company with a
director as to the terms of his employment in other positions, must be approved
by the audit committee, board of directors and shareholders. If the office
holder is a controlling shareholder or a relative of a controlling shareholder,
any extraordinary transaction, compensation, exemption, indemnification and
insurance of the office holder must be approved by our audit committee, board
of directors and shareholders, supported by the vote of at least one-third of
the shares of the non-controlling shareholders voting on the matter, or
provided that the total number of shares held by non-controlling shareholders
that voted against the proposal did not exceed one percent of all of the voting
rights in the company.

The
Israeli Companies Law requires that an office holder and a controlling shareholder
disclose promptly, and no later than by the first board meeting at which such
transaction is considered, any personal interest that he or she may have and
all related material information and documents, in connection with any existing
or proposed transaction of the company. Personal interest includes any personal
interest of the persons relative, or any corporation in which the person or
any relative of such person is an interested party. The disclosure requirement
does not apply where the office holder or controlling shareholders personal
interest is created only by the personal interest of a relative in a
transaction that is not an extraordinary transaction.

A
director who has a personal interest in a matter, which is considered at a meeting
of the board of directors or the audit committee, may not be present during the
discussions of the board of directors or audit committee and may not vote on
this matter, unless the transaction under consideration is not an extraordinary
transaction or the majority of the members of the board or the audit committee
have a personal interest, as the case may be. In the event the majority of the
members of the board or the audit committee have a personal interest, then the
approval of the general meeting of shareholders is also required.

Under
the Companies Regulations (Relief from Related Party Transactions), 5760-2000,
promulgated under the Israeli Companies Law, and amended in January 2002,
certain transactions between a company and its controlling shareholder(s) do
not require shareholder approval. In addition, under such regulations,
directors compensation and employment arrangements do not require the approval
of the shareholders if both the audit committee and the board of directors
agree that such arrangements only benefit the company or if the directors
compensation does not exceed the maximum amount of compensation for outside
directors determined by applicable regulations. Under very limited
circumstances, employment and compensation arrangements for an office holder
that is a controlling shareholder of the company or his relative do not
require the approval of shareholders. The foregoing relief will not apply 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, objects to the grant
of such relief, provided that such objection is submitted to the company in
writing not later than fourteen days from the date of the filing of a report
regarding the adoption of such resolution by the company. If such objection is
duly and timely submitted, then the transaction or compensation arrangement
will require shareholders approval as detailed above.

Board
of directors and shareholder approval is also required in the event a company
issues its securities in a private placement of securities that will cause a
person to become a controlling shareholder, or in the event a private placement
in which 20% or more of the companys outstanding share capital prior to the
placement are offered, the payment for which (in whole or in part) is not in
cash or not under market terms, and that issuance will (i) increase the
relative holdings of a shareholder that holds 5% or more of the companys
outstanding share capital, or (ii) cause any person to become a holder of more
than 5% of the companys outstanding share capital.

54

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Notwithstanding
all of the above, if any of the enumerated transactions requiring special
approvals is adverse to the companys interest, such approval would not be
effective.

Indemnification of Directors and Officers and
Limitations of Liability

Exculpation
of Office Holders. The Israeli Companies Law provides
that an Israeli company cannot exculpate an office holder from liability with
respect to a breach of his or her duty of loyalty. If permitted by its articles
of association, a company may exculpate in advance an office holder from his or
her liability to the company, in whole or in part, with respect to a breach of
his or her duty of care. However, a company may not exculpate in advance a
director from his or her liability to the company with respect to a breach of
his duty of care in the event of distributions.

Office
Holders Insurance. Israeli law provides that a
company may, if permitted by its articles of association, enter into a contract
to insure its office holders for liabilities incurred by the office holder with
a respect to an act performed in his or her capacity as an office holder, as a
result of: (i) a breach of the office holders duty of care to the company or
another person; (ii) a breach of the office holders duty of loyalty to the
company, provided that the office holder acted in good faith and had reasonable
cause to assume that the act would not prejudice the companys interests; and
(iii) a financial liability imposed upon the office holder in favor of another
person.

Indemnification
of Office Holders. Under Israeli law a company may, if
permitted by its articles of association, indemnify an office holder for acts
performed by the office holder in such capacity for (a) monetary liability
imposed upon the office holder in favor of another person by any court
judgment, including a settlement or an arbitration award approved by a court;
(b) reasonable litigation expenses, including attorneys fees, actually
incurred by the office holder as a result of an investigation or proceeding
instituted against him by a competent authority, provided that such
investigation or proceeding concluded without the filing of an indictment
against the office holder or the imposition of any monetary liability in lieu
of criminal proceedings, or concluded without the filing of an indictment
against the office holder and a monetary liability was imposed on him or her in
lieu of criminal proceedings with respect to a criminal offense that does not
require proof of criminal intent; and (c) reasonable litigation expenses,
including attorneys fees, actually incurred by the office holder or imposed
upon the office holder by a court: (i) in an action, suit or proceeding brought
against the office holder by or on behalf of the company or another person,
(ii) in connection with a criminal action in which the office holder was
acquitted, or (iii) in connection with a criminal action in which the office
holder was convicted of a criminal offence that does not require proof of
criminal intent.

Israeli
law provides that a companys articles of association may permit the company to
(a) indemnify an office holder retroactively, following a determination to this
effect made by the company after the occurrence of the event in respect of
which the office holder will be indemnified; and (b) undertake in advance to
indemnify an office holder, except that with respect to a monetary liability
imposed on the office holder by any judgment, settlement or court-approved
arbitration award, the undertaking must be limited to types of occurrences,
which, in the opinion of the companys board of directors, are, at the time of
the undertaking, foreseeable due to the companys activities and to an amount
or standard that the board of directors has determined is reasonable under the
circumstances.

55

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Limitations
on Exculpation, Insurance and Indemnification. These
provisions are specifically limited in their scope by Israeli law, which
provides that neither a provision of the articles of association permitting the
company to enter into a contract to insure the liability of an office holder,
nor a provision in the articles of association or a resolution of the board of
directors permitting the indemnification of an office holder, nor a provision
in the articles of association exculpating an office holder from duty to the
company shall be valid, where such insurance, indemnification or exculpation
relates to any of the following: (1) a breach by the office holder of his duty
of loyalty unless, with respect to insurance coverage or indemnification, the
office holder acted in good faith and had a reasonable basis to believe that the
act would not prejudice the company; (2) a breach by the office holder of his
duty of care if such breach was committed intentionally or recklessly, unless
the breach was committed only negligently; (3) any act or omission done with
the intent to unlawfully yield a personal benefit; or (4) any fine or
forfeiture imposed on the office holder. Pursuant to the Israeli Companies Law,
exculpation of, procurement of insurance coverage for, and an undertaking to
indemnify or indemnification of, our office holders must be approved by our
audit committee and our board of directors and, if the office holder is a
director, also by our shareholders.

Our
Articles of Association allow us to insure, indemnify and exempt our office
holders, subject to the provisions of the Israeli Companies Law. We maintain a
directors and officers liability insurance policy with a per claim and
aggregate coverage limit of $5 million, including legal costs incurred in
Israel. In addition, our Audit Committee, Board of Directors and shareholders
resolved to indemnify our office holders, pursuant to a standard
indemnification agreement that provides for indemnification of an office holder
in an amount up to $5 million. We have not to date provided letters of
indemnification to our officers or directors.

NASDAQ Exemptions and Home Country Practices

Under
NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers, such as
our company, are permitted to follow certain home country corporate governance
practices instead of certain provisions of Rule 4350. A foreign private issuer
that elects to follow a home country practice instead of any of such provisions
of Rule 4350, must submit to NASDAQ, in advance, a written statement from an
independent counsel in such issuers home country certifying that the issuers
practices are not prohibited by the home countrys laws.

On
July 7, 2005 and June 26, 2006, we provided NASDAQ with notices of
non-compliance with Rule 4350. We informed NASDAQ that we do not comply with
the following requirements of Rule 4350, and instead follow Israeli law and
practice in respect of such requirements:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the
  requirement regarding the process of nominating directors. Instead, we follow
  Israeli law and practice in accordance with which our directors are
  recommended by our board of directors for election by our shareholders. See
  above in this Item 6.C. Directors, Senior Management and Employees - Board
  Practices - Election of Directors.                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | the
  requirement regarding the compensation of our chief executive officer and all
  other executive officers. Instead, we follow Israeli law and practice in
  accordance with which our board of directors must approve all compensation
  arrangements for our chief executive officer and all compensation
  arrangements for officers are subject to the chief executive officers
  approval. See above in this Item 6.C. Directors, Senior Management and
  Employees - Compensation.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | the
  requirement that our independent directors have regularly scheduled meetings
  at which only independent directors are present. Under Israeli law
  independent directors are not required to hold executive sessions.                                                                                                                                                                                                                                                                   

56

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|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | ---------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |           | the
  requirement that we distribute to shareholders, and file with NASDAQ, copies
  of an annual report containing audited financial statements of our company
  and its subsidiaries within a reasonable period of time prior to our annual
  meeting of shareholders. Under Israeli law, as a company that is publicly
  traded both in Israel and outside of Israel, we are not required to
  distribute such annual reports to our shareholders. Our annual report on Form
  20-F and audited financial statements are available on our website (www.magal-ssl.com),
  and we will send it to shareholders upon written request.                        
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |           | the
  requirement to maintain a majority of independent directors, as defined under
  the NASDAQ Marketplace Rules. Instead, we follow Israeli law and practice
  which requires that we appoint at least two outside directors, within the
  meaning of the Israeli Companies Law, to our Board of Directors. In addition,
  we have the mandated three independent directors that meet the independent
  standards contained in the rules of the Securities and Exchange Commission
  and NASDAQ on our audit committee. See above in this Item 6C. Directors,
  Senior Management and Employees - Board Practices - Independent and Outside
  Directors.
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|D. | Employees.

As
of December 31, 2006, we employed 294 full time employees, of whom 34 were
employed in general management and administration, 43in marketing, 23 in
production management, 143 in production, installation and maintenance, and 51
in engineering and research and development. Of our 294 full time employees,
135 were employed in Israel, 49 were employed in the U.S., 78 were employed in
Canada and 32 were employed in various other countries.

As
of December 31, 2005, we employed 309 full time employees, of whom 34 were
employed in general management and administration, 47 in marketing, 20 in
production management, 155 in production, installation and maintenance, and 53
in engineering and research and development. Of our 309 full time employees,
129 were employed in Israel, 56 were employed in the U.S., 89 were employed in
Canada and 35 were employed in various other countries.

As
of December 31, 2004, we employed 303 full-time employees, of whom 32 were
employed in general management and administration, 55 in marketing, 19 in
production management, 148 in production, installation and maintenance, and 49
in engineering and research and development. Of our 303 full-time employees,
120 were employed in Israel, 64 were employed in the U.S., 87 were employed in
Canada and 32 were 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.

57

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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 22, 2007.

|                                                             |  |                                       |  |                                                 |       |   | 
|------------------------------------------------------------ |  | ------------------------------------- |  | ----------------------------------------------- | ----- | - | 
|Name                                                         |  | Number of Ordinary 
  Shares Owned(1) |  | Percentage of Outstanding 
  Ordinary Shares(2) |      
|                                                             |  |                                       |  |                                                 |      
|Jacob Even-Ezra(3)(6)(7)                                     |  | 348,969                               |  |                                                 | 3.32  | % | 
|Izhar Dekel(4)(7)                                            |  | 154,427                               |  |                                                 | 1.47  | % | 
|Raffi Netzer                                                 |  | *                                     |  |                                                 | *     |   | 
|Yehezkel Farber                                              |  | *                                     |  |                                                 | *     |   | 
|Zvi Dank                                                     |  | *                                     |  |                                                 | *     |   | 
|Raya Asher                                                   |  | *                                     |  |                                                 | *     |   | 
|Asaf Even-Ezra(6)(7)                                         |  | 121,426                               |  |                                                 | 1.16  | % | 
|Dany Pizen                                                   |  | *                                     |  |                                                 | *     |   | 
|Ofer Katz                                                    |  | *                                     |  |                                                 | *     |   | 
|Yehonatan Ben- Hamozeg                                       |  | *                                     |  |                                                 | *     |   | 
|Nathan Kirsh(5)                                              |  | 1,832,227                             |  |                                                 | 17.63 | % | 
|Jacob Nuss                                                   |  | -                                     |  |                                                 | -     | % | 
|Zeev Livne                                                   |  | -                                     |  |                                                 | -     | % | 
|Jacob Perry                                                  |  | -                                     |  |                                                 | -     | % | 
|Shaul Kobrinsky                                              |  | -                                     |  |                                                 | -     | % | 
|Anat Winner                                                  |  | -                                     |  |                                                 | -     | % | 
|All directors and executive officers as a group (16
persons) |  | 2,617,775                             |  |                                                 | 24.82 | % | 

|               
|---------------
|               
|*Less
  than 1%

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Beneficial ownership is
  determined in accordance with the rules of the Securities and Exchange
  Commission and generally includes voting or investment power with respect to
  securities. Ordinary shares relating to options or convertible debenture
  notes currently exercisable or exercisable within 60 days of the date of this
  table are deemed outstanding for computing the percentage of the person
  holding such securities but are not deemed outstanding for computing the
  percentage of any other person. Except as indicated by footnote, the persons
  named in the table above have sole voting and investment power with respect
  to all shares shown as beneficially owned by them.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(2) | The percentages shown are
  based on 10,394,248 ordinary shares issued and outstanding as of June 22,
  2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(3) | Includes 76,915 ordinary
  shares held by a trustee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(4) | Include Mr. Dekels
  beneficial ownership of 42,000 ordinary shares and 112,427 shares held by
  Mr. Dekels wife, Ornit Dekel.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(5) | Includes Mr. Kirshs
  beneficial ownership of 1,485,852 ordinary shares held by Mira Mag Inc.
  Mr. Kirsh is a trustee of the Eurona Foundation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

58

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As
of June 22, 2007,
the 16 directors and executive officers listed above, as a group, held options
to purchase 151,800of our ordinary shares at a weighted average exercise price
of $7.77 per share. Out of such options 94,500options expire in January 2009 and 57,300options expire in December 2010.

Stock Option Plan

On
October 27, 2003, our board of directors approved the 2003 Israeli Share Option
Plan (the 2003 Plan) which was approved by our shareholders in July 2004. The
Board has elected to allot the options under Israels capital gain tax
treatment.

Under
the 2003 Plan, stock options will be periodically granted to our employees,
directors, officers and consultants, in accordance with the decision of our
board of directors. Our board of directors has the authority to determine the
number of options, if any, which will be granted to each of the recipients, 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, and the
purchase price thereof. Subject to shareholder approval, the 2003 Plan will be
effective for ten years and shall terminate in October 2013.

Under
the 2003 Plan, 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.

Pursuant
to the provisions of the 2003 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.

As
of December 31, 2006, options to purchase 322,100 shares were outstanding and
additional options to purchase 301,475 shares were available for grant.

Grants
of stock options under the 2003 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 2003 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
22, 2007, 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.

|                                   |  |                                                          |  |                                                  |       |   | 
|---------------------------------- |  | -------------------------------------------------------- |  | ------------------------------------------------ | ----- | - | 
|Name                               |  | Number of
  Ordinary
  Shares
  Beneficially 
  Owned(1) |  | Percentage of
  Outstanding
  Ordinary Shares(2) |      
|                                   |  |                                                          |  |                                                  |      
|                                   |  |                                                          |  |                                                  |      
|Nathan Kirsh
  (3)                 |  | 1,832,227                                                |  |                                                  | 17.63 | % | 
|Mira Mag
  Inc.(4)                 |  | 1,485,852                                                |  |                                                  | 14.29 | % | 
|Diker
  Management LLC (5)         |  | 1,007,601                                                |  |                                                  | 9.69  | % | 
|Clough
  Capital Partners L.P. (6) |  | 711,669                                                  |  |                                                  | 6.85  | % | 

59

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Beneficial ownership is
  determined in accordance with the rules of the Securities and Exchange
  Commission and generally includes voting or investment power with respect to
  securities. Ordinary shares relating to options or convertible debenture
  notes currently exercisable or exercisable within 60 days of the date of this
  table are deemed outstanding for computing the percentage of the person
  holding such securities but are not deemed outstanding for computing the percentage
  of any other person. Except as indicated by footnote, the persons named in
  the table above have sole voting and investment power with respect to all
  shares shown as beneficially owned by them.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(2) | The percentages shown are
  based on 10,394,248 ordinary shares issued and outstanding as of June 22,
  2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(3) | Includes Mr. Kirshs
  beneficial ownership of 1,485,852 ordinary shares held by Mira Mag Inc. (see footnote (4) below).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(4) | Mira Mag Inc. is the holder
  of 1,485,852 ordinary
  shares. The beneficial owner of such shares is The Eurona Foundation. The
  Eurona Foundation is an entity controlled by Nathan Kirsh, the trustees of
  which are Prinz Michael von Liechtenstein, Altenbach 8,
  P.O. Box 339, FL-9490 Vaduz, Liechtenstein, and Nathan Kirsh, Spintex
  Village, Ezulwini, Swaziland.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(5) | Based
  solely upon, and qualified in its entirety with reference to, a Schedule 13G
  filed with the Securities and Exchange Commission on February 12, 2007. The Schedule 13G
  indicates that as the sole general partner of certain Diker partnerships with
  respect to stock directly owned by certain Diker funds, or the Diker Funds,
  Diker GP, has the power to vote and dispose of the shares owned by the Diker
  Funds and, accordingly, may be deemed the beneficial owner of such shares.
  Pursuant to investment advisory agreements, Diker Management serves as the
  investment manager of the Diker Funds. Accordingly, Diker Management may be
  deemed the beneficial owner of shares held by the Diker Funds. Charles M.
  Diker and Mark N. Diker are the managing members of each of Diker GP and
  Diker Management, and in that capacity direct their operations. Therefore,
  Charles M. Diker and Mark N. Diker may be deemed the beneficial owners of
  shares beneficially owned by Diker GP and Diker Management. The foregoing
  reporting persons disclaim all beneficial ownership, however, as affiliates
  of a Registered Investment Adviser, and in any case disclaim beneficial
  ownership except to the extent of their pecuniary interest in the shares.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(6) | Based
  solely upon, and qualified in its entirety with reference to, a Schedule
  13G/A filed with the Securities and Exchange Commission on February 6, 2007. The Schedule 13G/A
  indicates that the shares include shares beneficially owned by investment
  companies, pooled investment vehicles and other accounts for which Clough
  Capital Partners L.P. serves as investment adviser. Such shares may be deemed
  beneficially owner by (a) Clough Capital Partners L.P., (b) Clough Capital
  Partners LLC, the general partner of Clough Capital Partners L.P., and (c)
  Messrs. Clough, Canty and Brock, the managing members of Clough Capital
  Partners LLC. Each such reporting person disclaims beneficial ownership of
  such shares except to the extent of its respective pecuniary interest therein.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

Significant Changes in the Ownership of Major
Shareholders

In
March and April 2004, Mira Mag Inc. sold an aggregate of 2,429,836, or 29.6%,
of our ordinary shares in a series of open market transactions. In March and
April 2004, Mr. Even-Ezra sold an aggregate of 210,666, or 2.6%, of our
ordinary shares in a series of open market transactions.

On
April 19, 2005, Mr. Kirsh, a trustee of the Eurona Foundation, Mira Mag Inc.s
controlling shareholder, and Mr. Jacob Even-Ezra participated in the offering
of our ordinary shares and purchased 346,375 and 78,625 ordinary shares,
respectively, at a purchase price of $9.92 per ordinary share, the closing
price of our ordinary shares at the date of the offering.

60

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On
February 12, 2007, Diker GP, LLC, Diker Management LLC, or Diker Management,
Messrs. Charles M. Diker and Mark N. Diker filed an amendment to its Schedule
13G with the Securities and Exchange Commission reflecting beneficial ownership
of 1,007,601, or 9.70%, of our ordinary shares. The Schedule 13G indicates that
as the sole general partner of certain Diker partnerships with respect to stock
directly owned by certain Diker funds, or the Diker Funds, Diker GP, has the
power to vote and dispose of the shares owned by the Diker Funds and,
accordingly, may be deemed the beneficial owner of such shares. Pursuant to
investment advisory agreements, Diker Management serves as the investment
manager of the Diker Funds. Accordingly, Diker Management may be deemed the
beneficial owner of shares held by the Diker Funds. Charles M. Diker and Mark
N. Diker are the managing members of each of Diker GP and Diker Management, and
in that capacity direct their operations. Therefore, Charles M. Diker and Mark
N. Diker may be deemed the beneficial owners of shares beneficially owned by
Diker GP and Diker Management. The foregoing reporting persons disclaim all
beneficial ownership, however, as affiliates of a Registered Investment
Adviser, and in any case disclaim beneficial ownership except to the extent of
their pecuniary interest in the shares.

On
February 6, 2007 Clough Capital
Partners, L.P. filed an
amendment to its Schedule 13G with the Securities and Exchange Commission
reflecting beneficial ownership of 711,669 or 6.85% of our ordinary shares. The
Schedule 13 G reflects that 711,699 shares include shares beneficially owned by
investment companies, pooled investment vehicles and other accounts for which
Clough Capital Partners L.P. serves as investment adviser. Such shares may be
deemed beneficially owned by (a) Clough Capital Partners L.P., (b) Clough
Capital Partners LLC, the general partner of Clough Capital Partners L.P., and
(c) Messrs. Charles I. Clough, Jr. , James E. Canty and Eric A. Brock, the
managing members of Clough Capital Partners LLC. Each such reporting person
disclaims beneficial ownership of such shares except to the extent of its
respective pecuniary interest therein.

Major Shareholders Voting Rights

The
voting rights of our major shareholders do not differ from the voting rights of
other holders of our ordinary shares.

Record Holders

Based
on a review of the information provided to us by our transfer agent, as of June
25, 2007, there were 58 holders of record of our ordinary shares, of which 46 record holders holding
approximately 79.3% of our
ordinary shares had registered addresses in the United States and 10 record
holders holding approximately 17.2%
of our ordinary shares had registered addresses in Israel. These numbers are
not representative of the number of beneficial holders of our shares nor is it
representative of where such beneficial holders reside since many of these
ordinary shares were held of record by brokers or other nominees, including
CEDE & Co., the nominee for the Depositary Trust Company (the central
depositary for the U.S. brokerage community), which held approximately 76.2% of our outstanding ordinary
shares as of said date.

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

On
April 19, 2005 Mr. Kirsh, a trustee of the Eurona Foundation, Mira Mag Inc.s
controlling shareholder, and Mr. Even-Ezra participated in the offering of our
ordinary shares and purchased 346,375 and 78,625 ordinary shares, respectively,
at a purchase price of $9.92 per ordinary share, the closing price of our
ordinary shares at the date of the offering.

Sales to a Principal Shareholder

Our
U.S. subsidiary, Smart, provides video monitoring services to companies
controlled by Mr. Kirsh. The terms of the contracts under which we make sales
to these companies were negotiated on an arms-length basis and the terms of
such contracts are no more favorable to these companies than those it could
have obtained from an unaffiliated third party. Our sales to these companies
during the years ended December 31, 2004, 2005 and 2006 were $386,000, $671,000
and $765,000 respectively.

61

---

---



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
December 2000, our board of directors extended the term of
Mr. Dekels employment until such time as it is terminated by us or by
Mr. Dekel pursuant to the terms of the agreement. Under the Israeli
Companies Law, the terms of employment of Mr. Dekel, who is also a member of
our board of directors requires shareholders approval. Our shareholders
approved Mr. Dekels terms in July 2004. 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
2006, the total amount of our revenues from our facilities located outside of
Israel to customers outside of Israel was approximately $37.0 million, or 55.2%
of our total revenues. The total amount of our export revenues from our Israeli
facilities to countries outside of Israel was approximately $3.6 million, or
5.4% of our total revenues.

Legal Proceedings

In
May 2005 we entered into an agreement to supply comprehensive security
solutions for a sensitive site in Eastern Europe. As part of the agreement, we
received an advance payment, secured by a bank advanced payment guarantee that
was to be reduced proportionally as execution of the project progressed. In
addition, we issued the customer a performance bank guarantee. We commenced the
project and delivered some of the equipment and other deliverables to the
customer in 2005. In April 2006, the customer informed us that it was canceling
the agreement due to errors in the design documents that we submitted. In
addition, the customer did not make payments required under the agreement.
Based on its cancellation of the agreement, the customer collected $3.2 million
under the advanced payment guarantee on June 20, 2006. Due to this uncertainty,
we did not recognize any revenues from this project.

On
July 11, 2006 the customer made a demand for additional $1.4 million payment
under a bank performance guarantee for. Upon our motion, the District Court in
Haifa, Israel issued a temporary injunction against the payment of such
guarantee pending a hearing in August 2006. At the hearing, we reached a
settlement with the customer pursuant to which we paid the customer
approximately $700,000 of the disputed amount and the balance will be repaid
only if we are found liable for damages exceeding the amount paid by us. In
view of the above and due to the uncertainty of our preventing the forfeiture
of the bank performance guarantee, we included a $1.4 million provision in
respect of this guarantee in our financial statements for the year ended
December 31, 2005,. Based on the settlement, we cancelled the balance of the
provision made in our financial statements in 2006. In the event we will be unsuccessful in the arbitration, we may be
required to record an expense of $700,000 if the customer will be allowed to
enforce the bank performance guarantee.

62

---

---



We
believe that there is no factual or legal ground for the cancellation of the
agreement or the demand for payment under the bank performance guarantee, and
accordingly, we believe that the agreement is still valid. On April 28, 2006,
we commenced arbitration proceedings against the customer. In these proceedings
we asked the arbitrators to find that the agreement is valid and to enforce the
payments due to us pursuant to the agreement. The customer denied our
allegations and filed a counter-claim for liquidated damages in a foreign
currency which on December 31, 2006 was equal to approximately $4.5 million.
The hearing of the arbitration proceeding has concluded and is pending
resolution by the arbitration panel. Based on the opinion of our legal counsel,
we believe that there is a good likelihood that the arbitration will result in
a favorable determination. We intend to vigorously pursue our claim. However,
we may not be successful in the arbitration, which may result in a significant
negative impact on our financial results including the payment of penalties.

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 Distribution Policy

In
each of 1999 and 2000, we paid a cash dividend to our shareholders of $0.10 per
ordinary share, representing approximately 32.0% 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 33.0% of our net income in 2000. In each of August
2002 and 2003, we paid a 3.0% stock dividend as a final dividend for the years
ended December 31, 2001 and 2002, respectively.

On
January 27, 2004 we paid a cash dividend to our shareholders of $0.05 per
ordinary share, representing approximately 17.0% of our net income in 2003. In
August 2004, we paid a 5.0% stock dividend to our shareholders as a final
dividend for 2003.

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

Except as
otherwise disclosed in this annual report, there has been no material change in
our financial position since December 31, 2006.

63

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|        |                      
|------- | ---------------------
|ITEM 9. | The Offer and Listing

|   |                             
|-- | ----------------------------
|A. | Offer
  and Listing Details.

AnnualStock Information

Our
shares have traded on the NASDAQ Global Market since our initial public
offering in 1993 and on the Tel Aviv Stock Exchange since July 2001.

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 Global Market and
the Tel Aviv Stock Exchange:

|                                                                                                                                                                                                                                                                            |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ----- | ------------------------- | - | ---- |  | --------- | --------- | --------- |  | --------- | 
|                                                                                                                                                                                                                                                                            |  | NASDAQ
  Global Market |       | Tel Aviv
  Stock Exchange |  
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |  
|                                                                                                                                                                                                                                                                            |  | High                   |       | Low                       |   | High |  | Low       |          
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |   |      |  |           |          
|2002                                                                                                                                                                                                                                                                        |  |                        | 13.49 |                           |   | 4.57 |  |           | 59.60     |           |  | 22.24     | 
|2003                                                                                                                                                                                                                                                                        |  |                        | 9.97  |                           |   | 4.74 |  |           | 42.68     |           |  | 22.69     | 
|2004                                                                                                                                                                                                                                                                        |  |                        | 40.35 |                           |   | 6.75 |  |           | 156.68    |           |  | 32.25     | 
|2005                                                                                                                                                                                                                                                                        |  |                        | 12.22 |                           |   | 7.87 |  |           | 53.45     |           |  | 35.74     | 
|2006                                                                                                                                                                                                                                                                        |  |                        | 14.2  |                           |   | 8.51 |  |           | 64.78     |           |  | 36.10     | 
|                                                                                                                                                                                                                                                                           
|Quarterly
Stock Information                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                           
|The
following table sets forth, for each of the full financial quarters in the two
most recent full financial years and any subsequent period, the range of high ask
and low bid prices of our ordinary shares on the NASDAQ Global Market and the
Tel Aviv Stock Exchange:
|                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                            |  | NASDAQ Global Market   |       | Tel Aviv Stock Exchange   |  
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |  
|                                                                                                                                                                                                                                                                            |  | High                   |       | Low                       |   | High |  | Low       |          
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |   |      |  |           |          
|2005                                                                                                                                                                                                                                                                        |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|First
  Quarter                                                                                                                                                                                                                                                             |  | $                      | 12.22 |                           | $ | 9.50 |  |           | NIS 53.45 |           |  | NIS 42.27 | 
|Second
  Quarter                                                                                                                                                                                                                                                            |  |                        | 11.37 |                           |   | 7.89 |  |           | 49.35     |           |  | 36.19     | 
|Third
  Quarter                                                                                                                                                                                                                                                             |  |                        | 11.21 |                           |   | 7.87 |  |           | 50.13     |           |  | 35.74     | 
|Fourth
  Quarter                                                                                                                                                                                                                                                            |  |                        | 10.96 |                           |   | 8.40 |  |           | 49.56     |           |  | 39.24     | 
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|2006                                                                                                                                                                                                                                                                        |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|First
  Quarter                                                                                                                                                                                                                                                             |  | $                      | 14.2  |                           | $ | 8.75 |  |           | NIS 64.78 |           |  | NIS 40.61 | 
|Second
  Quarter                                                                                                                                                                                                                                                            |  |                        | 13.36 |                           |   | 9.01 |  |           | 61.15     |           |  | 40.57     | 
|Third
  Quarter                                                                                                                                                                                                                                                             |  |                        | 11.70 |                           |   | 8.96 |  |           | 51.50     |           |  | 39.40     | 
|Fourth
  Quarter                                                                                                                                                                                                                                                            |  |                        | 10.60 |                           |   | 8.51 |  |           | 44.00     |           |  | 36.10     | 
|                                                                                                                                                                                                                                                                            |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|2007                                                                                                                                                                                                                                                                        |  |                        |       |                           |   |      |  |           |           |           |  |           | 
|First
  Quarter                                                                                                                                                                                                                                                             |  | $                      | 12.00 |                           | $ | 8.53 |  | NIS 51.00 |           | NIS 36.25 | 

64

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Monthly
Stock Information

The
following table sets forth, for each of the most recent six months, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ Global
Market and the Tel Aviv Stock Exchange:

|         |  |                      |       |                         |  |       |  |           |       |           |  |       | 
|-------- |  | -------------------- | ----- | ----------------------- |  | ----- |  | --------- | ----- | --------- |  | ----- | 
|         |  | NASDAQ Global Market |       | Tel Aviv Stock Exchange | 
|         |  |                      |       |                         | 
|         |  | High                 |       | Low                     |  | High  |  | Low       |      
|         |  |                      |       |                         |  |       |  |           |      
|2006     |  |                      |       |                         |  |       |  |           |       |           |  |       | 
|December |  |                      | 10.08 |                         |  | 8.80  |  | NIS 41.86 |       | NIS 36.10 | 
|         |  |                      |       |                         |  |       |  |           |       |           |  |       | 
|2007     |  |                      |       |                         |  |       |  |           |       |           |  |       | 
|January  |  |                      | 9.57  |                         |  | 8.53  |  |           | 41.90 |           |  | 36.25 | 
|February |  |                      | 10.89 |                         |  | 9.14  |  |           | 46.00 |           |  | 37.57 | 
|March    |  |                      | 12.00 |                         |  | 10.25 |  |           | 51.00 |           |  | 43.00 | 
|April    |  |                      | 11.18 |                         |  | 10.00 |  |           | 46.06 |           |  | 41.65 | 
|May      |  |                      | 11.15 |                         |  | 10.00 |  |           | 44.87 |           |  | 40.20 | 

|                                                                                                                                                                                                                                                   |                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------
|B.                                                                                                                                                                                                                                                 | Plan
  of Distribution. 
|                                                                                                                                                                                                                                                   |                         
|                                                                                                                                                                                                                                                   | Not
  applicable.       
|                                                                                                                                                                                                                                                   |                         
|C.                                                                                                                                                                                                                                                 | Markets.                
|                                                                                                                                                                                                                                                   |                         
|Our ordinary
  shares have traded on the NASDAQ Global Market under the symbol MAGS since
  our initial public offering in 1993. Our ordinary shares have also traded on
  the Tel Aviv Stock Exchange under the symbol MAGS since July 1, 2001.
|                                                                                                                                                                                                                                                   |                         
|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.

Purposes and Objects of the Company

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.

65

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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 Israeli 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 outside director.

According
to the Israeli 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 Israeli 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
Israeli 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.  For a discussion regarding
approval of director and office compensation see Item 6.C. Directors, Senior
Management and Employees-Board Practices - Approval of Related-Party
Transactions under Israeli Law.

Rights Attached to Shares

Our
authorized share capital consists of NIS 19,748,000 ordinary shares, par
value NIS 1.00 each.  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.

The
rights attached to the ordinary shares are as follows:

Dividends
Rights

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.

66

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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 Israeli
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 held 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 Israeli 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:

| |   |                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |  | amend the
  memorandum or the articles of association;                                                                                         
| |   |                                                                                                                                                
| |  | change the
  share capital, for example, increasing or canceling the authorized share
  capital or modifying the rights attached to shares; and
| |   |                                                                                                                                                
| |  | 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.  Pursuant to our articles of association, our
directors (except the outside directors) are elected at our annual general
meeting of shareholders by a vote of the holders of a majority of the voting
power represented and voting at such meeting. and hold office until the next
annual general meeting of shareholders and until their successors have been
elected.  All the members of our Board
of Directors (except the outside directors) may be reelected upon completion of
their term of office.  For information regarding
the election of outside directors, see Item 6C. Directors, Senior Management
and Employees  Directors and Senior Management - Board Practices - Election of
Directors.

Rights
to Share in the Companys Profits

Our
shareholders have the right to share in our profits distributed as a dividend
or any other permitted distributions. See this Item 10B. Additional Information 
Memorandum and Articles of Association  Rights Attached to Shares  Dividend
Rights.

Liquidation
Rights

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.

67

---

---



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 Related Party Transactions.

Capital
Calls

Under
our memorandum of association and the Israeli 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

Under
the Israeli Companies Law a company must convene an annual meeting of
shareholders at least once every calendar year and within fifteen months of the
last annual meeting.  Depending on the
matter to be voted upon, notice of at least 21 days or 35 days prior to the
date of the meeting is required.  Our
board of directors may, in its discretion, convene additional meetings as
special general meetings.  In
addition, the board must convene a special general meeting upon the demand of
two of the directors, 25% of the nominated directors, one or more shareholders
having at least 5% of the outstanding share capital and at least 1% of the
voting power in the company, or one or more shareholders having at least 5% of
the voting power in the company.  See this
Additional Information - Memorandum and Articles of Association- Rights Attached to
Shares-Voting Rights.

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 fourteen
to twenty-one days or, in the event of a vote by ballots, between twenty eight
to forty days prior the date the general meeting of shareholders is held.

68

---

---



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
Israeli 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 boards
confirmation that there is no reasonable doubt that after the merger the
surviving company will be able to fulfill its obligations towards its
creditors.  Each company must notify its
creditors about the contemplated merger.
Under our articles of association, such merger must be
approved by are solution of the
shareholders, as explained above.  The
approval of the merger by the general meetings of shareholders of the companies
is also subject to additional approval requirements as specified in the Israeli
Companies Law and regulations promulgated thereunder.  See also Item 6C. Directors, Senior Management and Employees 
Board Practices  Approval of Related Party Transactions Under Israeli Law.

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.

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|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 discussion of Israeli and United States tax consequences
material to us and to our shareholders.
To the extent that the discussion is based on new tax legislation which
has not been subject to judicial or administrative interpretation, the views
expressed in the discussion might not be accepted by the tax authorities in
question.  The discussion is not
intended, and should not be construed, as legal or professional tax advice and
does not exhaust all possible tax considerations.

Holders of our ordinary
shares should consult their own tax advisors as to the United States, Israeli
or other tax consequences of the purchase, ownership and disposition of
ordinary shares, including, in particular, the effect of any foreign, state or
local taxes.

ISRAELI TAX CONSIDERATIONS

The
following is a summary of the current tax structure applicable to companies in
Israel, with special reference to its effect on us. The following also contains
a discussion of the material Israeli tax consequences to purchasers of our
ordinary shares and Israeli government programs benefiting us. This summary
does not discuss all the aspects of Israeli tax law that may be relevant to a
particular investor in light of his or her personal investment circumstances or
to some types of investors subject to special treatment under Israeli law.

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General Corporate Tax Structure

Israeli companies are subject to income tax
on their worldwide income regardless of the territorial source of such
income.  Pursuant to tax reform
legislation that came into effect in 2003, the corporate tax rate is to undergo
staged reductions to 25% by the year 2010.
In order to implement these reductions, the corporate tax rate declined
from 31% in 2006, to 29% in 2007 and scheduled to decline to 27% in 2008, and
26% in 2009.

However, the effective tax rate payable by a company that derives
income from an approved enterprise, discussed further below, may be
considerably less.  See Tax Benefits
under the Law for the Encouragement of Capital Investments, 1959.

Encouragement of Capital Investments Law,
5719-1959

General

The
Encouragement of Capital Investments Law, 5719-1959, 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, Trade and Labor 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 relates 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 29%, 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 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.

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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 benefit period and within 12 years
after the period.  The company must
withhold this tax at the source.

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.

On
April 1, 2005, an amendment to the Investments Law came into force.  Pursuant to the amendment, a companys
facility will be granted the status of Approved Enterprise only if it is
proven to be an industrial facility (as defined in the Investments Law) that
contributes to the economic independence of the Israeli economy and is a
competitive facility that contributes to the Israeli gross domestic
product.  The amendment provides that
the Israeli Tax Authority and not the Investment Center will be responsible for
an Approved Enterprise under the alternative package of benefits, referred to
as a Benefiting Facility.  A company
wishing to receive the tax benefits afforded to a Benefiting Facility is
required to select the tax year from which the period of benefits under the
Investment Law are to commence by simply notifying the Israeli Tax Authority
within 12 months of the end of that year. In order to be recognized as owning a
Benefiting Facility, a company is required to meet a number of conditions set
forth in the amendment, including making a minimal investment in manufacturing
assets for the Benefiting Facility and having completed a cooling-off period of
no less than two to four years from the companys previous year of commencement
of benefits under the Investments Law.

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Pursuant
to the amendment, a company with a Benefiting Facility is entitled, in each tax
year, to accelerated depreciation for the manufacturing assets used by the
Benefiting Facility and to certain tax benefits, provided that no more than 12
to 14 years have passed since the beginning of the year of commencement of
benefits under the Investments Law. The tax benefits granted to a Benefiting
Factory are determined according one of the following new tax routes:

(a)          Similar
to the currently available alternative route, exemption from corporate tax on
undistributed income for a period of two to ten years, depending on the
geographic location of the Benefiting Facility within Israel, and a reduced
corporate tax rate of 10% to 25% for the remainder of the benefits period,
depending on the level of foreign investment in each year.  Benefits may be granted for a term of from
seven to ten years, depending on the level of foreign investment in the
company.  If the company pays a dividend
out of income derived from the Benefiting Facility during the tax exemption period,
such income will be subject to corporate tax at the applicable rate (10%-25%).
The company is required to withhold tax at the source at a rate of 15% from any
dividends distributed from income derived from the Benefiting Facility.

(b)          A
special tax route enabling companies owning facilities in certain geographical
locations in Israel to pay corporate tax at the rate of 11.5% on income of the
Benefiting Facility. The benefits period is ten years. Upon payment of
dividends, the company is required to withhold tax at source at a rate of 15%
for Israeli residents and at a rate of 4% for foreign residents.

(c)          A
special tax route that provides a full exemption from corporate tax and from
tax with respect to dividends for companies with an annual income of at least
NIS 13-20 billion that have invested a total of between NIS 600900 million in
facilities in certain geographical locations in Israel.

Generally,
a company that is Abundant in Foreign Investment (as defined in the Investments
Law) is entitled to an extension of the benefits period by an additional five
years, depending on the rate of its income that is derived in foreign currency.

The
amendment changes the definition of foreign investment in the Investments Law
so that instead of an investment of foreign currency in the company, the
definition now requires a minimal investment of NIS 5 million by foreign
investors. Furthermore, such definition now also includes the purchase of
shares of a company from another shareholder; provided that the companys
outstanding and paid-up share capital exceeds NIS 5 million. Such changes to
the aforementioned definition will take effect retroactively from 2003.

The
amendment will apply to approved enterprise programs in which the year of
commencement of benefits under the Investments Law is 2004 or later, unless
such programs received approval from the Investment Center on or prior to
December 31, 2004 in which case the provisions of the amendment will not apply.

On
March 3, 2007, we received a pre-ruling from the Israeli Tax Authority for our
request for a Benefiting Facility, regarding eligibility for benefits under the
Amendment. Our income from this program is tax-exempt for a period of two
years, and is 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). We did not enjoy from tax benefits in this program yet.

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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 hold more than 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 two approved enterprise expansion programs which were approved
in 1997 and 2001, and under which we are entitled to tax benefits.  The periods of benefits for two of our
approved enterprise programs will expire in 2007 and in 2012, respectively.  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.

Encouragement of Industry (Taxes) Law, 5729-1969

Under
the Encouragement of Industry (Taxes)
Law, 5729-1969, or the Industry Encouragement Law, Industrial
Companies are entitled to certain corporate tax benefits, including, among
others:

| |   |                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Deduction,
  under certain conditions, of purchases of know-how and patents over an
  eight-year period for tax purposes;                                                                                                           
| |   |                                                                                                                                                                                                                                     
| |  | Right to
  elect, under specified conditions, to file a consolidated tax return with
  additional related Israeli industrial companies; and                                                                                         
| |   |                                                                                                                                                                                                                                     
| |  | Accelerated
  depreciation rates on equipment and buildings; and                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                     
| |  | Deductions
  over a three-year period of expenses in connection with the issuance and
  listing of shares on the Tel Aviv Stock
  Exchange, or TASE or, following January 1, 2003, on a recognized stock market
  outside of Israel.

Eligibility
for benefits under the Industry Encouragement Law is not subject to the prior
approval of any governmental authority. Under the Industry Encouragement Law,
an Industrial Company is a company resident in Israel, at least 90% of the
income of which, in any tax year, determined in Israeli currency, exclusive of
income from government loans, capital gains, interest and dividends, is derived
from an Industrial Enterprise owned by it.
An Industrial Enterprise is an enterprise owned by an Industrial
Company, whose major activity in a given tax year is industrial production
activity.

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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.

Encouragement of Industrial Research and
Development Law, 5744-1984

Under
the Encouragement of Industrial Research and Development Law, 5744-1984, or 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 up to 50% of certain of the projects expenditures, as determined by the
research committee.

In
exchange, the recipient of such grants is required to pay the OCS royalties
from the revenues derived from products incorporating technology developed
within the framework of the approved research and development program or
derived from such program (including ancillary services in connection with such
program), usually up to100% of the U.S. dollar-linked value of the total grants
received in respect of such program, plus LIBOR interest.

The
terms of the Israeli government participation also require that products
developed with government grants be manufactured in Israel.  However, under the regulations of the
Research Law, upon the approval of the OCS, some of the manufacturing volume
may be performed outside Israel, provided that the grant recipient pays
royalties at an increased rate. The Research Law also allows for the approval
of grants in cases in which the applicant declares that part or all of the
manufacturing will be performed outside of Israel or by foreign residents and
the research committee is convinced that this is essential for the execution of
the program.  The Research Law also
provides that know-how developed under an approved research and development
program may not be transferred to third parties in Israel without the prior
approval of the research committee.  The
Research Law further provides that the know-how developed under an approved
research and development program may not be transferred to any third parties
outside Israel.  No approval is required
for the sale or export of any products resulting from such research and
development.

However,
In June 2005, an amendment to the Research Law became effective, which
amendment was intended to make the Research Law more compatible with the global
business environment by, among other things, relaxing restrictions on the
transfer of manufacturing rights outside Israel and on the transfer of
OCS-funded know-how outside of Israel.  The
amendment permits the OCS, among other things, to approve the transfer of
manufacturing rights outside Israel in exchange for an import of different
manufacturing into Israel as a substitute, in lieu of demanding the recipient
to pay increased royalties as described above. The amendment further permits,
under certain circumstances and subject to the OCSs prior approval, the
transfer outside Israel of know-how that has been funded by OCS, generally in
the following cases: (a) the grant recipient pays to the OCS a portion of the
consideration paid for such funded know-how (according to certain formulas),
(b) the grant recipient receives know-how from a third party in exchange for
its funded know-how, or (c) such transfer of funded know-how arises in
connection with certain types of cooperation in research and development
activities.

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The
Research Law imposes reporting requirements with respect to certain changes in
the ownership of a grant recipient.  The
law requires the grant recipient and its controlling shareholders and interested
parties to notify the OCS and obtaining the approval of the OCS for, any change
in control of the recipient or a change in the holdings of the means of control
of the recipient that results in a foreign resident becoming an interested
party directly in the recipient and requires the new interested party to
undertake to the OCS to comply with the Research Law.  In addition, the rules of the OCS may require prior approval of
the OCS or additional information or representations in respect of certain of
such events. For this purpose, control is defined as the ability to direct
the activities of a company other than any ability arising solely from serving
as an officer or director of the company.
A person is presumed to have control if such person holds 50% or more of
the means of control of a company.
Means of control refers to voting rights or the right to appoint
directors or the chief executive officer.
An interested party of a company includes a holder of 5% or more of
its outstanding share capital or voting rights, its chief executive officer and
directors, someone who has the right to appoint its chief executive officer or
at least one director, and a company with respect to which any of the foregoing
interested parties owns 25% or more of the outstanding share capital or voting
rights or has the right to appoint 25% or more of the directors.  Accordingly, any foreign resident who
acquires 5% or more of our ordinary shares will be required to notify the OCS
that it has become an interested party and to sign an undertaking to comply
with the Research Law.

The
funds generally available for grants by the OCS were reduced as of 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 (Inflationary Adjustments) Law, 5745- 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:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | There is a
  special tax adjustment for the preservation of equity whereby some corporate
  assets are classified broadly into fixed assets and non-fixed assets.                                                                                                                                                                                                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | Where a
  companys equity, as defined in such law, exceeds the depreciated cost of
  fixed assets, a deduction from taxable income that takes into account the
  effect of the applicable annual rate of inflation on such excess is allowed
  up to a ceiling of 70% of taxable income in any single tax year, with the
  unused portion permitted to be carried forward on a linked basis.  If the depreciated cost of fixed assets
  exceeds a companys equity, then such excess multiplied by the applicable
  annual rate of inflation is added to taxable income.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | 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.                                                                                                                                                                                                                                                                                                                                                                                          

Stamp Tax

Documents
signed following January 1, 2006, are not subject to stamp tax.

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Capital Gains Tax on Sales of Our Ordinary
Shares

Under
a recent amendment the income tax ordinance [New Version], 5721-1961, commonly
referred to as the Tax Ordinance, the general rule is that Israeli resident,
individuals are subject to a 20% tax rate on the real capital gains derived on
or after January 1, 2003 .  Substantial
individual shareholders (who are defined as shareholders of 10% or more of the
shares of the company on the date of the sale of the shares or any date during
the 12 months before the sale of the shares) are subject to a 25% tax rate on
the real capital gains derived on or after January 1, 2003 from the sale of
shares. Notwithstanding the above, capital gains of an Israeli resident
individual from the sale of non-index linked debentures, commercial securities,
State loans and/or loans, is subject to a 15% tax rate on the real capital
gains derived on or after January 1, 2003 from the sale of securities, while
Substantial individual shareholders of such non-index linked securities are
subject to a 20% tax rate on the real capital gains derived on or after January
1, 2003 from the sale of such securities.

For
the tax years 2006-2009, Israeli resident companies who were not subject to the
provisions of Article 6 of the Income Tax Law (Inflationary Adjustments), Law
(which deals with the purchase and sale of securities publicly traded on a
recognized stock exchange during period of inflation) prior to August 10, 2005
are subject to 25% tax rate on real capital gains derived on or after January
1, 2003 from the sale of securities publicly traded on a recognized stock
exchange.  Notwithstanding the above,
Israeli resident companies who are subject to the provisions of Article 6 of
the (Inflationary Adjustments), prior to August 10, 2005,are subject to regular
corporate tax rate on real capital gains derived from the sale of securities
publicly traded on a recognized stock exchange.

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.

Under
income tax regulations foreign residents, who sell shares of an Israeli company
publicly traded on a recognized stock exchange outside of Israel, will be exempt
from tax subject to the satisfaction of all following conditions:

| |   |                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------
| |  | The capital gain is not attributable to a
  permanent establishment in Israel.                                         
| |   |                                                                                                                        
| |  | The shares were purchased after the first
  initial public offering on the recognized stock exchange outside of Israel.

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. The Treaty does not relate to U.S. state or local
taxes.

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Taxation ofForeign Holders
of Shares

Foreign
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
after January 1, 2006 other than bonus shares or stock dividends, income tax at
the rate of 20% will be withheld on dividends distributed to Israeli individual
shareholders or to  foreign residents. On
distributions of dividends to Substantial individual shareholders (who are
defined as shareholders of 10% or more of the shares of the company on the date
of the sale of the shares or any date during the 12 months before the sale of
the shares),  income tax at the
rate of 25%  will be withheld.

The
foregoing tax rates are withheld at source, unless a different rate is provided
in a treaty between Israel and the shareholders country of residence (for
instance, under
the provisions of the Treaty between Israel and the United States a 12.5% tax
rate is imposed on dividends not generated by an approved enterprise if the
foreign resident is a U.S. corporation that holds 10% of a companys voting
power, and 15% on dividends generated by an approved enterprise).  In addition under the Treaty, the maximum
tax on dividends paid to a holder of ordinary shares who is a U.S. resident
within the meaning of the Treaty will be 25%.

Controlled Foreign Corporation

In
general, and subject to the provisions of all relevant legislation, 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 (generally
referred to as a Controlled Foreign Corporation, or CFC), is liable for tax on
the portion of his income attributed to holdings in such corporation, as if
such income was distributed to him as a dividend.

Share Allocation to Employees

In
general, the section of the Tax Ordinance that deals with taxation of share
allocation to employees and/or officers (excluding controlling members)
provides that a company may choose one of the following three courses of
taxation which course must be approved by the assessing officer: (i) work
income course for shares held 12 months in trust; (ii) capital gains course for
shares held 24 months in trust; and (iii) allocation not through a trustee.
Needless to say, each of the courses (i)  (iii) has different tax
consequences.

As
of January 1, 2006, the periods mentioned in courses (i) and (ii) shall
commence as of the date of grant and not as end the end of the tax year in
which the shares were granted.

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United States Federal Income Tax Consequences

The
following is a summary of certain material U.S. federal income tax consequences
that apply to U.S. Holders who hold ordinary shares as capital assets.  This summary is based on the United States
Internal Revenue Code of 1986, as amended (the Code), Treasury regulations
promulgated thereunder, judicial and administrative interpretations thereof,
and the U.S.-Israel Tax Treaty, all as in effect on the date hereof and all of
which are subject to change either prospectively or retroactively.  This summary does not address all tax
considerations that may be relevant with respect to an investment in ordinary shares.  This summary does not discuss all the tax
consequences that may be relevant to a U.S. Holder in light of such holders
particular circumstances or to U.S. Holders subject to special rules, including
persons that are non-U.S. Holders, broker-dealers, financial institutions,
certain insurance companies, investors liable for alternative minimum tax,
tax-exempt organizations, regulated investment companies, taxpayers whose
functional currency is not the U.S. dollar, persons who hold the ordinary shares
through partnerships or other pass-through entities, persons who acquired their
ordinary shares through the exercise or cancellation of employee stock options
or otherwise as compensation for services, investors that actually or
constructively own 10 percent or more of our voting shares, and investors
holding ordinary shares as part of a straddle or appreciated financial position
or as part of a hedging or conversion transaction.

If
a partnership or an entity treated as a partnership for U.S. federal income tax
purposes owns ordinary shares, the U.S. federal income tax treatment of a
partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
common shares.

This
summary does not address the effect of any U.S. federal taxation other than
U.S. federal income taxation.  In
addition, this summary does not include any discussion of state, local or
foreign taxation.

You
are urged to consult your tax advisors regarding the foreign and United States
federal, state and local tax considerations of an investment in ordinary
shares.

For
purposes of this summary, the term U.S. Holder means an individual who is a
citizen or, for U.S. federal income tax purposes, a resident of the United
States, a corporation or other entity taxable as a corporation created or
organized in or under the laws of the United States or any political
subdivision thereof, an estate whose income is subject to U.S. federal income
tax regardless of its source, or a trust that (a) is subject to the primary
supervision of a court within the United States and the control of one or more
U.S. persons or (b) has a valid election in effect under applicable U.S.
Treasury regulations to be treated as a U.S. person.

Taxation of Dividends

Subject
to the discussion below under the heading Passive Foreign Investment
Companies, the gross amount of any distributions received with respect to
ordinary shares, including the amount of any Israeli taxes withheld therefrom,
will constitute dividends for U.S. federal income tax purposes, to the extent
of our current and accumulated earnings and profits as determined for U.S.
federal income tax purposes. You will be required to include this amount of
dividends in gross income as ordinary income. Distributions in excess of our
current and accumulated earnings and profits will be treated as a non taxable
return of capital to the extent of your tax basis in the ordinary shares and
any amount in excess of your tax basis will be treated as gain from the sale of
ordinary shares. See Disposition of Ordinary Shares below for the discussion
on the taxation of capital gains. Dividends will not qualify for the dividends
received deduction generally available to corporations under Section 243 of the
Code.

Dividends
that we pay in NIS, including the amount of any Israeli taxes withheld
therefrom, will be included in your income in a U.S. dollar amount calculated
by reference to the exchange rate in effect on the day such dividends are
received.  A U.S. Holder who receives payment
in NIS and converts NIS into U.S. dollars at an exchange rate other than the
rate in effect on such day may have a foreign currency exchange gain or loss
that would be treated as ordinary income or loss.  U.S. Holders should consult their own tax advisors concerning the
U.S. tax consequences of acquiring, holding and disposing of NIS.

79

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Subject
to complex limitations, any Israeli withholding tax imposed on such dividends
will be a foreign income tax eligible for credit against a U.S. Holders U.S.
federal income tax liability (or, alternatively, for deduction against income
in determining such tax liability).  The
limitations set out in the Code include computational rules under which foreign
tax credits allowable with respect to specific classes of income cannot exceed
the U.S. federal income taxes otherwise payable with respect to each such class
of income.  Dividends generally will be
treated as foreign source passive category income or, in the case of certain
U.S. Holders, general category income for United States foreign tax credit
purposes.    Further, there are special
rules for computing the foreign tax credit limitation of a taxpayer who
receives dividends subject to a reduced rate of tax, see discussion below.  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 31-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.  The rules relating to the
determination of the foreign tax credit are complex, and you should consult
with your personal tax advisors to determine whether and to what extent you
would be entitled to this credit.

Subject
to certain limitations, qualified dividend income received by a noncorporate
U.S. Holder in tax years beginning on or before December 31, 2010 will be
subject to tax at a reduced maximum tax rate of 15 percent.  Distributions taxable as dividends paid on
the ordinary shares should qualify for the 15 percent rate provided that
either: (i) we are entitled to benefits under the income tax treaty between the
United States and Israel (the Treaty) or (ii) the ordinary shares are readily
tradable on an established securities market in the United States and certain
other requirements are met.  We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the
United States.  However, no assurance
can be given that the ordinary shares will remain readily tradable.  The rate reduction does not apply unless
certain holding period requirements are satisfied.  With respect to the ordinary shares, the U.S. Holder must have
held such shares for at least 61 days during the 121-day period beginning 60
days before the ex-dividend date.  The
rate reduction also does not apply to dividends received from a passive foreign
investment company see discussion below, or in respect of certain hedged
positions or in certain other situations.
The legislation enacting the reduced tax rate contains special rules for
computing the foreign tax credit limitation of a taxpayer who receives
dividends subject to the reduced tax rate.
U.S. Holders of ordinary shares should consult their own tax advisors
regarding the effect of these rules in their particular circumstances.

Disposition
of Ordinary Shares

If
you sell or otherwise dispose of ordinary shares, you will recognize gain or
loss for U.S. federal income tax purposes in an amount equal to the difference
between the amount realized on the sale or other disposition and your adjusted
tax basis in the ordinary shares. Subject to the discussion below under the
heading Passive Foreign Investment Companies, such gain or loss generally
will be capital gain or loss and will be long-term capital gain or loss if you
have held the ordinary shares for more than one year at the time of the sale or
other disposition. In general, any gain that you recognize on the sale or other
disposition of ordinary shares will be U.S.-source for purposes of the foreign
tax credit limitation; losses will generally be allocated against U.S. source
income.  Deduction of capital losses is
subject to certain limitations under the Code.

80

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In
the case of a cash basis U.S. Holder who receives NIS in connection with the
sale or disposition of ordinary shares, the amount realized will be based on
the U.S. dollar value of the NIS received with respect to the ordinary shares
as determined on the settlement date of such exchange. A U.S. Holder who
receives payment in NIS and converts NIS into United States dollars at a
conversion rate other than the rate in effect on the settlement date may have a
foreign currency exchange gain or loss that would be treated as ordinary income
or loss.

An
accrual basis U.S. Holder may elect the same treatment required of cash basis
taxpayers with respect to a sale or disposition of ordinary shares, provided
that the election is applied consistently from year to year.  Such election may not be changed without the
consent of the Internal Revenue Service (the IRS).  In the event that an accrual basis U.S. Holder does not elect to
be treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Holder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing
on the trade date and the settlement date.
Any such currency gain or loss would be treated as ordinary income or loss
and would be in addition to gain or loss, if any, recognized by such U.S.
Holder on the sale or disposition of such ordinary shares.

Passive
Foreign Investment Companies

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

Based
on our current and projected income, assets and activities, we believe that we
are not currently a PFIC nor do we expect to become a PFIC in the foreseeable
future.  However, because the
determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, there can be no assurances that we will
not become a PFIC for any future taxable year.

If
we are treated as a PFIC for any taxable year, dividends would not qualify for
the reduced maximum tax rate, discussed above, and, unless you elect either to
treat your investment in ordinary shares as an investment in a qualified
electing fund (a QEF election) or to mark to market your ordinary shares,
as described below:

| |   |                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | you would be
  required to allocate income recognized upon receiving certain dividends or
  gain recognized upon the disposition of ordinary shares ratably over the
  holding period for such ordinary shares,                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                   
| |  | the amount
  allocated to each year during which we are considered a PFIC other than the
  year of the dividend payment or disposition would be subject to tax at the
  highest individual or corporate tax rate, as the case may be, in effect for
  that year and an interest charge would be imposed with respect to the
  resulting tax liability allocated to each such year,

81

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| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                      
| |  | the amount
  allocated to the current taxable year and any taxable year before we became a PFIC would be taxable as ordinary
  income in the current year, and                       
| |   |                                                                                                                                                                                      
| |  | you would be
  required to file an annual return on IRS Form 8621 regarding distributions
  received with respect to ordinary shares and any gain realized on your
  ordinary shares.

If
you make either a timely QEF election or a timely mark-to-market election in
respect of your ordinary shares, you would not be subject to the rules
described above. If you make a timely QEF election, you would be required to
include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you.  You would not be
eligible to make a QEF election unless we comply with certain applicable
information reporting requirements.

Alternatively,
if the ordinary shares are considered marketable stock and if you elect to
mark-to-market your ordinary shares, you will generally include in income any
excess of the fair market value of the ordinary shares at the close of each tax
year over your adjusted basis in the ordinary shares. If the fair market value
of the ordinary shares had depreciated below your adjusted basis at the close
of the tax year, you may generally deduct the excess of the adjusted basis of
the ordinary shares over its fair market value at that time. However, such
deductions generally would be limited to the net mark-to-market gains, if any,
that you included in income with respect to such ordinary shares in prior
years. Income recognized and deductions allowed under the mark-to-market
provisions, as well as any gain or loss on the disposition of ordinary shares
with respect to which the mark-to-market election is made, is treated as
ordinary income or loss (except that loss on a disposition of ordinary shares
is treated as capital loss to the extent the loss exceeds the net
mark-to-market gains, if any, that you included in income with respect to such
ordinary shares in prior years).  Gain or loss from the disposition of
ordinary shares (as to which a mark-to-market election was made) in a year in
which we are no longer a PFIC, will be capital gain or loss.

Backup
Withholding and Information Reporting

Payments
in respect of ordinary shares may be subject to information reporting to the
U.S. Internal Revenue Service and to U.S. backup withholding tax at a rate
equal to the third highest income tax rate applicable to individuals (which,
under current law, is 28%).  Backup
withholding will not apply, however, if you (i) are a corporation or come
within certain exempt categories, and demonstrate the fact when so required, or
(ii) furnish a correct taxpayer identification number and make any other
required certification.

Backup
withholding is not an additional tax.
Amounts withheld under the backup withholding rules may be credited
against a U.S. Holders U.S. tax liability, and a U.S. Holder may obtain a
refund of any excess amounts withheld under the backup withholding rules by
filing the appropriate claim for refund with the IRS.

Any
U.S. holder who holds 10% or more in vote or value of our ordinary shares will
be subject to certain additional United States information reporting
requirements.

82

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U.S.
Gift and Estate Tax

An
individual U.S. Holder of ordinary shares will be subject to U.S. gift and
estate taxes with respect to ordinary shares in the same manner and to the same
extent as with respect to other types of personal property.

|   |                             
|-- | ----------------------------
|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 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 100 F Street, N.E., Room 1580, 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.

In
addition, since we are also listed on the TASE, we submit copies of all our
filings with the SEC to the Israeli Securities Authority and TASE. Such copies
can be retrieved electronically through the TASE internet messaging system
(www.maya.tase.co.il) and, in addition, with respect to filings made as of
November 2003, through the MAGNA distribution site of the Israeli Securities
Authority (www.magna.isa.gov.il).

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

83

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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
short-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 MaturityWeighted Average Interest Rate(U.S. dollars in thousands)

|                                 |  |      |        |      |   |       |   |               |      |       |   |                                     |   |   |        |   |   |        | 
|-------------------------------- |  | ---- | ------ | ---- | - | ----- | - | ------------- | ---- | ----- | - | ----------------------------------- | - | - | ------ | - | - | ------ | 
|Liabilities:                     |  | 2007 |        | 2008 |   | 2009  |   | 20010-
  2011 |      | Total |   | Fair
  Value at
  December 31, 2006 |  
|                                 |  |      |        |      |   |       |   |               |      |       |   |                                     |  
|Short Term Loans                 |  | $    | 17,026 |      | $ | -     |   | $             | -    |       | $ | -                                   |   | $ | 17,026 |   | $ | 17,026 | 
|Weighted Average Interest
  Rate |  |      | 5.74   | %    |   | -     | % |               | -    | %     |   | -                                   | % |   | 5.74   | % |   | -      | 
|Long Term Loans                  |  | $    | 795    |      | $ | 4,303 |   | $             | 813  |       | $ | 2,283                               |   | $ | 8,194  |   | $ | 8,158  | 
|Weighted Average Interest
  Rate |  |      | 5.79   | %    |   | 6.04  | % |               | 5.78 | %     |   | 5.65                                | % |   | 5.89   | % |   | -      | 

Foreign Currency Exchange Risk

We
sell most of our products in North America, Europe and Israel.    A portion of our revenues in Israel are
made in NIS, and we expect to make NIS denominated revenues in 2007 as
well.  Our foreign currency exposure
with respect to our revenues 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 2007, the NIS has depreciated by approximately
0.1% against the dollar.  We are also subject
to exchange rate fluctuations related to our activities in Canada.

Because
exchange rates between the NIS and the dollar fluctuate continuously, exchange
rate fluctuations, particularly larger periodic devaluations, may have an
impact on our profitability and period-to-period comparisons of our results.
In2002 and 2005, the rate of devaluation of the NIS against the dollar was 7.3%
and 6.8%, respectively, while in 2003, 2004 and 2006 the NIS was revaluated in
relation to the dollar by 7.6%, 1.6% and 8.2%, respectively. A portion of our
expenses, primarily labor expenses, is incurred in NIS and a part of our
revenues are quoted in NIS. Additionally, certain assets especially trade
receivables, as well as part of our liabilities are denominated in NIS. Our
results may be adversely affected by devaluation of the NIS in relation to the
dollar (or if such devaluation is on lagging basis), if our revenues in NIS are
higher than our expenses in NIS and/or the amount of our assets in NIS are
higher than our liabilities in NIS. On the contrary, our results may be
adversely affected by the revaluation of the NIS in relation to the dollar (or
if such revaluation is on a lagging basis), if the amount of our expenses in
NIS are higher than the amount of our revenues in NIS and/or the amount of our
liabilities in NIS are higher than our assets in NIS.

We
are also subject to exchange rate fluctuations related to our activities in
Canada.

84

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During the years ended December 31, 2004 and  2005, foreign currency fluctuations had an adverse impact
on our results of operations, and our foreign exchange losses, net were
$120,000 and $145,000 respectively. During
the year ended December 31, 2006, our foreign exchange gains, net were
$276,000. We cannot assure you that in the future our results of operations
may not be materially adversely affected by currency fluctuations.

To
protect against the change in the forecasted foreign currency cash flows of
certain sale arrangements resulting from changes in the exchange rate during
2004, 2005 and 2006, we entered into forward contracts in order to hedge
portions of our forecasted revenue and unbilled accounts receivable denominated
in Euros and Polish Zlotys.  We have
designated the forward instruments as cash flow hedges for accounting purposes.

For
derivative instruments designated as cash flow hedges (i.e., hedging the exposure
to variability in expected future cash flows that is attributable to a
particular risk), the effective portion of the gain or loss on the derivative
instrument is reported as a component of other comprehensive income and
reclassified into earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged transaction
affects earnings.

We
determined that it is probable that a sales arrangement denominated in Polish Zlotys and the
related forecasted revenues and unbilled accounts receivable would not occur by
the end of the specified time period.
Accordingly, changes in the fair value of the forward contracts were
recorded in financial expenses in the years ended December 31, 2005 and 2006.

On
October 1, 2006, we changed our functional currency from the dollar to NIS.
From the date of change in functional currency, the hedge of the revenues in
Euros is no longer effective. Changes in the fair value of the forward
contracts from October 1, 2006 were charged to financial expenses.

We
recorded $ 0, $ 110,000 and $ 915,000 as financial expenses related to forward
contracts transactions, in 2004, 2005 and 2006, respectively.

|         |                                                         
|-------- | --------------------------------------------------------
|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
|                  |                                                                               
|Not
  applicable.
|                  |                                                                               
|ITEM 15.          | Controls and Procedures                                                       
|                  |                                                                               
|Not
  applicable.

85

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|          |                        
|--------- | -----------------------
|ITEM 15T. | Controls and Procedures

Disclosure
Controls and Procedures

We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in its Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms, and that such information
is accumulated and communicated to our chief executive officer and chief
financial officer to allow timely decisions regarding required disclosure.  Our management, including our chief
executive officer and chief financial officer, conducted an evaluation of our
disclosure controls and procedures, as defined under Exchange Act Rule
13a-15(e), as of the end of the period covered by this Annual Report on
Form 20-F.  Based upon that
evaluation, our chief executive officer and chief financial officer have
concluded that, as of such date, our disclosure controls and procedures were
effective.

Managements
Annual Report on Internal Control over Financial Reporting

Our
management, including our chief executive officer and chief financial officer,
is responsible for establishing and maintaining adequate internal control over
financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f).  Our internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States.  Internal
control over financial reporting includes those policies and procedures that:
(1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of our assets, (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that the our receipts and expenditures are being
made only in accordance with appropriate authorizations; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of our assets that could have a material
effect on the financial statements.

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

Our
chief executive officer and chief financial officer assessed the effectiveness
of our internal control over financial reporting as of the as of the end of the
period covered by this annual report.
Their assessment included an evaluation of the design of our internal
control over financial reporting and testing of the operational effectiveness
of our internal control over financial reporting. Based on their assessment,
our chief executive officer and chief financial officer believe that, as of
such date, we maintained effective internal control over financial reporting.

This
annual report does not include an attestation report of our independent
registered public accounting firm regarding internal control over financial
report.  Managements report was not
subject to attestation by our independent registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit us to provide only managements report in this annual report.

86

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Changes
in Internal Control over Financial Reporting

There
was no change in our internal controls over financial reporting that occurred
during the period covered by this annual report that has materially affected,
or is reasonably likely to materially affect, our internal controls over
financial reporting.

|          |                                 
|--------- | --------------------------------
|ITEM 16A. | Audit Committee Financial Expert

Our
Board of Directors has determined that Mrs. Anat Winner, an independent
director, meets the definition of an audit committee financial expert, as
defined by rules of the Securities and Exchange Commission.   For a brief listing of Mrs. Winners
relevant experience, see Item 6.A. Directors, Senior Management and Employees
- Directors and Senior Management.

|          |               
|--------- | --------------
|ITEM 16B. | Code of Ethics

We
have adopted a code of ethics that applies to our chief executive officer and
all senior financial officers of our company, including the chief financial
officer, chief accounting officer or controller, or persons performing similar
functions.  The code of ethics is
publicly available on our website at www.magal-ssl.com.  Written copies are available upon
request.  If we make any substantive
amendment to the code of ethics or grant any waivers, including any implicit
waiver, from a provision of the codes of ethics, we will disclose the nature of
such amendment or waiver on our website.

|          |                                       
|--------- | --------------------------------------
|ITEM 16C. | Principal Accountant Fees and Services

Fees
Paid to Independent Public Accountants

The
following table sets forth, for each of the years indicated, the fees paid to
our principal independent registered public accounting firm, Kost Forer Gabbay
& Kasierer.  All of such fees were
pre-approved by our Audit Committee.

|                    |  |                           |         |      |   |         | 
|------------------- |  | ------------------------- | ------- | ---- | - | ------- | 
|                    |  | Year Ended
  December 31, |        
|                    |  |                           |        
|Services
  Rendered |  | 2005                      |         | 2006 |  
|                    |  |                           |         |      |  
|Audit (1)           |  | $                         | 266,936 |      | $ | 384,013 | 
|Audit-related (2)   |  |                           | -       |      |   | -       | 
|Tax (3)             |  |                           | 45,100  |      |   | 27,169  | 
|Other (4)           |  |                           | 194,124 |      |   | 19,393  | 
|                    |  |                           |         |      |   |         | 
|Total               |  | $                         | 506,160 |      | $ | 430,575 | 

| |     |                                                                                                                                                            
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |    
| | (1) | Audit fees consist of
  services that would normally be provided in connection with statutory and
  regulatory filings or engagements.                     
| |     |                                                                                                                                                            
| | (2) | Audit-related fees relate
  to assurance and associated services that traditionally are performed by the
  independent accountant, including due diligence.
| |     |                                                                                                                                                            
| | (3) | Tax fees relate to services
  performed by the tax division for tax compliance.                                                                            
| |     |                                                                                                                                                            
| | (4) | Other fees in 2005 include mainly fees related to our public offering.                                                                                     

Pre-Approval Policies
and Procedures

Our audit
committee has adopted a policy and procedures for the pre-approval of audit and
non-audit services rendered by our independent public accounting firm, Kost
Forer Gabbay & Kasierer and their affiliates.  Pre-approval of an audit or non-audit service may be given as a
general pre-approval, as part of the audit committees approval of the scope of
the engagement of our independent auditor, or on an individual basis.  Any proposed services exceeding general
pre-approved levels also requires specific pre-approval by our audit
committee.  The policy prohibits
retention of the independent public accountants to perform the prohibited
non-audit functions defined in Section 201 of the Sarbanes-Oxley Act or the
rules of the SEC, and also requires the audit committee to consider whether
proposed services are compatible with the independence of the public
accountants.

87

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|          |                                                          
|--------- | ---------------------------------------------------------
|ITEM 16D. | Exemptions from the Listing Standards for Audit Committee

Not
applicable.

|          |                                                                      
|--------- | ---------------------------------------------------------------------
|ITEM 16E. | Purchase of Equity Securities by the Issuer and Affiliated Purchasers

Issuer
Purchase of Equity Securities

Neither
we nor any affiliated purchaser has purchased any of our securities during
2006.

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.

Consolidated Financial Statements

|                                                             |  |       
|------------------------------------------------------------ |  | ------
|Index to Financial
  Statements                              |  | F-1   
|                                                             |  |       
|Report of Independent
  Registered Public Accounting Firm    |  | F-2   
|                                                             |  |       
|Consolidated Balance
  Sheets                                |  | F-3-4 
|                                                             |  |       
|Consolidated Statements of
  Income                          |  | F-5   
|                                                             |  |       
|Consolidated Statements of
  Changes in Shareholders Equity |  | F-6   
|                                                             |  |       
|Consolidated Statements of
  Cash Flows                      |  | F-7-8 
|                                                             |  |       
|Notes to Consolidated
  Financial Statements                 |  | F-9-42

88

---

---



|         |         
|-------- | --------
|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 Share                                                                                              
|              |  |                                                                                                                                              
|2.2****       |  | The
  Registrants Stock Option Plan (1993), as amended                                                                                      
|              |  |                                                                                                                                              
|12.1          |  | Certification
  of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of
  the Securities Exchange Act, as amended        
|              |  |                                                                                                                                              
|12.2          |  | Certification
  of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of
  the Securities Exchange Act, as amended        
|              |  |                                                                                                                                              
|13.1          |  | Certification
  of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to
  Section 906 of the Sarbanes-Oxley Act of 2002
|              |  |                                                                                                                                              
|13.2          |  | Certification
  of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to
  Section 906 of the Sarbanes-Oxley Act of 2002
|              |  |                                                                                                                                              
|15.1          |  | Schedule of
  Valuation and Qualifying Accounts                                                                                              
|              |  |                                                                                                                                              
|15.2          |  | Consent of
  Kost Forer Gabbay & Kasierer                                                                                                    
|              |  |                                                                                                                                              
|15.3          |  | Consent of
  Salles, Sáinz - Grant Thornton, S. C.                                                                                           

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

89

---

---



MAGAL SECURITY SYSTEMS LTD. AND ITS
SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2006

IN U.S. DOLLARS

INDEX

|                                                          |               
|--------------------------------------------------------- | --------------
|                                                          | Page          
|                                                          |               
|                                                         
|Report of Independent Registered Public
  Accounting Firm | F  2         
|                                                          |               
|Consolidated Balance Sheets                               | F  3  F  4 
|                                                          |               
|Consolidated Statements of Operations                     | F  5         
|                                                          |               
|Statements of Changes in Shareholders
  Equity           | F  6         
|                                                          |               
|Consolidated Statements of Cash Flows                     | F  7  F  8 
|                                                          |               
|Notes to Consolidated Financial Statements                | F  9  F  42



---

F  1

---

---



(ERNST & YOUNG LOGO)

REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

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, 2005 and
2006, and the related consolidated statements of operations, changes in
shareholders equity and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the responsibility
of the Companys management. Our responsibility is to express an opinion on
these financial statements based on our audits.

We
did not audit the financial statements of a certain subsidiary, whose assets
constitute approximately 3.2% and 4.1% of total consolidated assets as of
December 31, 2005 and 2006, respectively, and whose revenues constitute
approximately 5.2% and 11.1% of total consolidated revenues for the years ended
December 31, 2005 and 2006, respectively. The financial statements of this
company were audited by other auditors, whose report has been furnished to us,
and our opinion, insofar as it relates to amounts included for this subsidiary,
is based solely on the report of the other auditors.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting.
Our audits included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting. Accordingly,
we express no such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.

In
our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2005 and 2006, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006, in conformity with accounting principles
generally accepted in the United States.

As
discussed in Note 2n to the consolidated financial statements, in 2006 the
Company adopted Statement of Financial Accounting Standard Board No. 123
(revised 2004) Share Based Payment.

|                                  |                                                                                                    
|--------------------------------- | ---------------------------------------------------------------------------------------------------
|Tel-Aviv,
  IsraelJune 28,
  2007 | /s/Kost
  Forer Gabbay and KasiererKOST FORER
  GABBAY & KASIERERA Member of
  Ernst & Young Global

F  2

---

---



|                                                  
|--------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|CONSOLIDATED BALANCE SHEETS                       
|                                                  
|U.S. dollars in thousands                         

|                                                                                                                            |  |              |         |      |   |         | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                                                                                                            |  | December 31, |        
|                                                                                                                            |  |              |        
|                                                                                                                            |  | 2005         |         | 2006 |  
|                                                                                                                            |  |              |         |      |  
|ASSETS                                                                                                                      |  |              |         |      |   |         | 
|                                                                                                                            |  |              |         |      |   |         | 
|CURRENT
  ASSETS:                                                                                                           |  |              |         |      |   |         | 
|Cash and cash equivalents                                                                                                   |  | $            | 10,099  |      | $ | 4,908   | 
|Marketable securities (Note 3)                                                                                              |  |              | -       |      |   | 3,067   | 
|Short-term bank deposits                                                                                                    |  |              | 17,053  |      |   | 14,186  | 
|Trade receivables (net of allowance for
  doubtful accounts of $306 and $493 at December 31, 2005 and 2006,
  respectively) |  |              | 24,012  |      |   | 28,027  | 
|Unbilled accounts receivable                                                                                                |  |              | 8,596   |      |   | 5,389   | 
|Other accounts receivable and prepaid
  expenses (Note 4)                                                                   |  |              | 4,455   |      |   | 3,995   | 
|Deferred income taxes                                                                                                       |  |              | 1,187   |      |   | 1,604   | 
|Inventories (Note 5)                                                                                                        |  |              | 11,110  |      |   | 13,971  | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|Total current
  assets                                                                                                      |  |              | 76,512  |      |   | 75,147  | 
|                                                                                                                            |  |              |         |      |   |         | 
|LONG-TERM
  INVESTMENTS AND RECEIVABLES:                                                                                    |  |              |         |      |   |         | 
|Long-term trade receivables                                                                                                 |  |              | 290     |      |   | 224     | 
|Long-term loan (Note 11i)                                                                                                   |  |              | -       |      |   | 622     | 
|Long-term bank deposits                                                                                                     |  |              | 1,800   |      |   | 4,800   | 
|Severance pay fund                                                                                                          |  |              | 2,070   |      |   | 2,401   | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|Total long-term
  investments and receivables                                                                               |  |              | 4,160   |      |   | 8,047   | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|PROPERTY AND
  EQUIPMENT, NET (Note 6)                                                                                      |  |              | 15,587  |      |   | 14,366  | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|DEFERRED
  INCOME TAXES                                                                                                     |  |              | 828     |      |   | 686     | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|OTHER
  INTANGIBLE ASSETS, NET (Note 7)                                                                                     |  |              | 569     |      |   | 1,150   | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|GOODWILL                                                                                                                    |  |              | 4,186   |      |   | 4,285   | 
|                                                                                                                            |  |              |         |      |   |         | 
|                                                                                                                           
|Total assets                                                                                                                |  | $            | 101,842 |      | $ | 103,681 | 
|                                                                                                                            |  |              |         |      |   |         | 

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

F  3

---

---



|                                                             
|-------------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.
  AND ITS SUBSIDIARIES           
|CONSOLIDATED BALANCE SHEETS                                  
|                                                             
|U.S. dollars in thousands (except share and
  per share data)

|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | ------- | ---- | - | ------- | 
|                                                                                                                                                                                                             |  | December 31, |        
|                                                                                                                                                                                                             |  |              |        
|                                                                                                                                                                                                             |  | 2005         |         | 2006 |  
|                                                                                                                                                                                                             |  |              |         |      |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                         |  |              |         |      |   |         | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|CURRENT LIABILITIES:                                                                                                                                                                                         |  |              |         |      |   |         | 
|Short-term bank credit (Note 8)                                                                                                                                                                              |  | $            | 18,068  |      | $ | 17,026  | 
|Current maturities of long-term bank debt
  (Note 10)                                                                                                                                                        |  |              | 3,647   |      |   | 795     | 
|Trade payables                                                                                                                                                                                               |  |              | 6,360   |      |   | 6,001   | 
|Customer advances                                                                                                                                                                                            |  |              | 3,990   |      |   | 1,230   | 
|Other accounts payable and accrued expenses
  (Note 9)                                                                                                                                                       |  |              | 8,914   |      |   | 9,782   | 
|Unrealized losses on hedging forward
  contracts                                                                                                                                                             |  |              | 79      |      |   | 596     | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|                                                                                                                                                                                                            
|Total
  current liabilities                                                                                                                                                                                  |  |              | 41,058  |      |   | 35,430  | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|LONG-TERM LIABILITIES:                                                                                                                                                                                       |  |              |         |      |   |         | 
|Unrealized losses on hedging forward
  contracts                                                                                                                                                             |  |              | 50      |      |   | -       | 
|Long-term bank debt (Note 10)                                                                                                                                                                                |  |              | 1,653   |      |   | 7,399   | 
|Long-term accounts payable (Note 11d)                                                                                                                                                                        |  |              | -       |      |   | 178     | 
|Accrued severance pay                                                                                                                                                                                        |  |              | 2,131   |      |   | 2,524   | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|                                                                                                                                                                                                            
|Totallong-term
  liabilities                                                                                                                                                                                 |  |              | 3,834   |      |   | 10,101  | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|COMMITMENTS AND CONTINGENT LIABILITIES
  (Note 11)                                                                                                                                                           |  |              |         |      |   |         | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|SHAREHOLDERS EQUITY (Note 12):                                                                                                                                                                              |  |              |         |      |   |         | 
|Share capital -                                                                                                                                                                                              |  |              |         |      |   |         | 
|Ordinary shares of NIS 1 par value
  - Authorized: 19,748,000 shares at December 31, 2005 and 2006; Issued and
  outstanding: 10,372,448 and 10,391,548 shares at December 31, 2005 and
  2006, respectively |  |              | 3,220   |      |   | 3,224   | 
|Additional paid-in capital                                                                                                                                                                                   |  |              | 47,509  |      |   | 47,681  | 
|Deferred stock compensation                                                                                                                                                                                  |  |              | (38     | )    |   | -       | 
|Accumulated other comprehensive income                                                                                                                                                                       |  |              | 2,435   |      |   | 2,314   | 
|Foreign currency translation (Companys
  stand alone financial statements)                                                                                                                                  |  |              | -       |      |   | 297     | 
|Retained earnings                                                                                                                                                                                            |  |              | 3,824   |      |   | 4,634   | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|                                                                                                                                                                                                            
|Total
  shareholders equity                                                                                                                                                                                 |  |              | 56,950  |      |   | 58,150  | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 
|                                                                                                                                                                                                            
|Total
  liabilities and shareholders equity                                                                                                                                                                 |  | $            | 101,842 |      | $ | 103,681 | 
|                                                                                                                                                                                                             |  |              |         |      |   |         | 

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

F  4

---

---



|                                                 
|-------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                      
|AND ITS SUBSIDIARIES                             
|CONSOLIDATED STATEMENTS OF OPERATIONS            
|                                                 
|U.S. dollars in thousands (except per share data)

|                                                                   |  |                           |        |      |   |        |   |   |        |  
|------------------------------------------------------------------ |  | ------------------------- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                   |  | Year ended
  December 31, |       
|                                                                   |  |                           |       
|                                                                   |  | 2004                      |        | 2005 |   | 2006   |  
|                                                                   |  |                           |        |      |   |        |  
|                                                                  
|Revenues                                                           |  | $                         | 60,468 |      | $ | 61,282 |   | $ | 66,958 |  
|Cost of revenues                                                   |  |                           | 33,226 |      |   | 39,154 |   |   | 40,231 |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|Gross profit                                                       |  |                           | 27,242 |      |   | 22,128 |   |   | 26,727 |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Operating expenses:                                                |  |                           |        |      |   |        |   |   |        |  
|Research and development, net (Note 17a)                           |  |                           | 4,683  |      |   | 5,265  |   |   | 5,378  |  
|Selling and marketing, net                                         |  |                           | 12,519 |      |   | 13,180 |   |   | 12,079 |  
|General and administrative                                         |  |                           | 5,771  |      |   | 5,961  |   |   | 6,533  |  
|Award granted by principal shareholders
  (Note 1b)                |  |                           | 1,200  |      |   | -      |   |   | -      |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|Total operating
  expenses                                         |  |                           | 24,173 |      |   | 24,406 |   |   | 23,990 |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|Operating income (loss)                                            |  |                           | 3,069  |      |   | (2,278 | ) |   | 2,737  |  
|Financial expenses, net (Note 17b)                                 |  |                           | 762    |      |   | 800    |   |   | 851    |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Income (loss) before income taxes                                  |  |                           | 2,307  |      |   | (3,078 | ) |   | 1,886  |  
|Income taxes (tax benefit) (Note 14)                               |  |                           | 1,133  |      |   | (23    | ) |   | 948    |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Income (loss) from continuing operations                           |  |                           | 1,174  |      |   | (3,055 | ) |   | 938    |  
|Loss from discontinued operations, net
  (Note 18)                 |  |                           | (121   | )    |   | (156   | ) |   | (128   | )
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Net income (loss)                                                  |  | $                         | 1,053  |      | $ | (3,211 | ) | $ | 810    |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Basic net earnings (loss) per share from
  continuing operations   |  | $                         | 0.13   |      | $ | (0.31  | ) | $ | 0.09   |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|Basic net loss per share from discontinued
  operations            |  |                           | (0.01  | )    |   | (0.01  | ) |   | (0.01  | )
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Basic net earnings (loss) per share (Note
  13)                    |  | $                         | 0.12   |      | $ | (0.32  | ) | $ | 0.08   |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Diluted net earnings (loss) per share from
  continuing operations |  | $                         | 0.13   |      | $ | (0.31  | ) | $ | 0.09   |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|Diluted net loss per share from
  discontinued operations          |  |                           | (0.01  | )    |   | (0.01  | ) |   | (0.01  | )
|                                                                   |  |                           |        |      |   |        |   |   |        |  
|                                                                  
|Diluted net earnings (loss) per share (Note
  13)                  |  | $                         | 0.12   |      | $ | (0.32  | ) | $ | 0.08   |  
|                                                                   |  |                           |        |      |   |        |   |   |        |  

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

F  5

---

---



|                                             
|---------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                  
|AND ITS SUBSIDIARIES                         
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|                                             
|U.S. dollars in thousands (except share data)

|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | ----------------- | - | ------------------------- |  | -------------------------- | ------ | ------------------------------------------------ | - | ---------------------------------------------- | - | ----------------- | ----- | ------------------------------------ | - | ------------------------- | - | - | ------ | - | - | ------ | - | - | ------ | -
|                                                                                                                 |  | Number of
  shares |            | Ordinary
  shares |   | Additional paid-incapital |  | Deferredstock compensation |        | Accumulated
  other
  comprehensiveincome (loss) |   | Foreign 
  currency
  translation -the Company |   | Retained earnings |       | Total 
  comprehensive income (loss) |   | Total shareholdersequity |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |  
|Balance as of
  January 1, 2004                                                                                  |  |                    | 8,035,779  |                   | $ | 2,683                     |  | $                          | 24,098 |                                                  | $ | -                                              |   | $                 | 479   |                                      | $ | -                         |   | $ | 11,724 |   |   |        |   | $ | 38,984 |  
|Exercise of stock
  options                                                                                      |  |                    | 225,338    |                   |   | 51                        |  |                            | 916    |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 967    |  
|Deferred stock
  compensation related to officers options grant                                                 |  |                    | -          |                   |   | -                         |  |                            | 661    |                                                  |   | (661                                           | ) |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | -      |  
|Amortization of
  deferred stock-based compensation                                                              |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | 184                                            |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 184    |  
|Award granted by
  principal shareholders                                                                        |  |                    | -          |                   |   | -                         |  |                            | 1,200  |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 1,200  |  
|Stock dividend                                                                                                   |  |                    | 411,331    |                   |   | 91                        |  |                            | 5,651  |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | (5,742 | ) |   |        |   |   | -      |  
|Comprehensive
  income:                                                                                          |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Net income                                                                                                       |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | 1,053  |   | $ | 1,053  |   |   | 1,053  |  
|Unrealized gains
  on forward contracts, net                                                                     |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | 103   |                                      |   | -                         |   |   | -      |   |   | 103    |   |   | 103    |  
|Foreign currency
  translation adjustments                                                                       |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | 1,057 |                                      |   | -                         |   |   | -      |   |   | 1,057  |   |   | 1,057  |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Total
  comprehensive income                                                                                     |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   | $ | 2,213  |   |   |        |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Balance as of
  December 31, 2004                                                                                |  |                    | 8,672,448  |                   |   | 2,825                     |  |                            | 32,526 |                                                  |   | (477                                           | ) |                   | 1,639 |                                      |   | -                         |   |   | 7,035  |   |   |        |   |   | 43,548 |  
|Issuance of share
  capital, net                                                                                 |  |                    | 1,700,000  |                   |   | 395                       |  |                            | 14,793 |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 15,188 |  
|Amortization of
  deferred stock-based compensation                                                              |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | 439                                            |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 439    |  
|Deferred taxes on
  stock options                                                                                |  |                    | -          |                   |   | -                         |  |                            | 190    |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 190    |  
|Comprehensive
  income (loss):                                                                                   |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Net loss                                                                                                         |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | (3,211 | ) | $ | (3,211 | ) |   | (3,211 | )
|Unrealized gains
  on forward contracts, net                                                                     |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | 709   |                                      |   | -                         |   |   | -      |   |   | 709    |   |   | 709    |  
|Foreign currency
  translation adjustments                                                                       |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | 87    |                                      |   | -                         |   |   | -      |   |   | 87     |   |   | 87     |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Total comprehensive
  loss                                                                                       |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   | $ | (2,415 | ) |   |        |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Balance as of
  December 31, 2005                                                                                |  |                    | 10,372,448 |                   |   | 3,220                     |  |                            | 47,509 |                                                  |   | (38                                            | ) |                   | 2,435 |                                      |   | -                         |   |   | 3,824  |   |   |        |   |   | 56,950 |  
|Reclassification
  of deferred stock compensation into additional paid-in capital upon adoption
  of SFAS 123(R) |  |                    | -          |                   |   | -                         |  |                            | (38    | )                                                |   | 38                                             |   |                   | -     |                                      |   | -                         |   |   | -      |   |   | -      |   |   | -      |  
|Amortization of
  deferred stock-based compensation                                                              |  |                    | -          |                   |   | -                         |  |                            | 51     |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 51     |  
|Exercise of stock
  options                                                                                      |  |                    | 19,100     |                   |   | 4                         |  |                            | 159    |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | -      |   |   |        |   |   | 163    |  
|Comprehensive income
  (loss):                                                                                   |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Net income                                                                                                       |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | -     |                                      |   | -                         |   |   | 810    |   | $ | 810    |   |   | 810    |  
|Unrealized losses
  on forward contracts, net                                                                    |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | (36   | )                                    |   | -                         |   |   | -      |   |   | (36    | ) |   | (36    | )
|Unrealized loss
  from available-for-sale securities, net                                                        |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | (13   | )                                    |   | -                         |   |   | -      |   |   | (13    | ) |   | (13    | )
|Foreign currency
  translation adjustments from change of functional currency, net                               |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | -     |                                      |   | (355                      | ) |   | -      |   |   | -      |   |   | (355   | )
|Foreign currency
  translation adjustments                                                                       |  |                    | -          |                   |   | -                         |  |                            | -      |                                                  |   | -                                              |   |                   | (72   | )                                    |   | 652                       |   |   | -      |   |   | (72    | ) |   | 580    |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Total
  comprehensive income                                                                                     |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   | $ | 689    |   |   |        |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Balance as of
  December 31, 2006                                                                                |  |                    | 10,391,548 |                   |   | 3,224                     |  |                            | 47,681 |                                                  | $ | -                                              |   | $                 | 2,314 |                                      | $ | 297                       |   |   | 4,634  |   |   |        |   | $ | 58,150 |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Accumulated
  unrealized losses on forward contracts, net                                                        |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   | $                 | (31   | )                                    |   |                           |   |   |        |   |   |        |   |   |        |  
|Accumulated
  unrealized losses from available-for-sale securities, net                                          |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   | (13   | )                                    |   |                           |   |   |        |   |   |        |   |   |        |  
|Accumulated
  foreign currency translation adjustments                                                           |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   | 2,358 |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|Accumulated other
  comprehensive income as of December 31, 2006                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   | $                 | 2,314 |                                      |   |                           |   |   |        |   |   |        |   |   |        |  
|                                                                                                                 |  |                    |            |                   |   |                           |  |                            |        |                                                  |   |                                                |   |                   |       |                                      |   |                           |   |   |        |   |   |        |   |   |        |  

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

F  6

---

---



MAGAL SECURITY SYSTEMS LTD. 
AND ITS SUBSIDIARTIES


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

|                                                                                                              |  |                         |        |      |   |         |   |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------- | - | - | ------- | -
|                                                                                                              |  | Year ended December 31,
|                                                                                                              |  |                         |       
|                                                                                                              |  | 2004                    |        | 2005 |   | 2006    |  
|                                                                                                              |  |                         |        |      |   |         |  
|Cash flows from operating
  activities:                                                                       |  |                         |        |      |   |         |   |   |         |  
|                                                                                                             
|Net income (loss)                                                                                             |  | $                       | 1,053  |      | $ | (3,211  | ) | $ | 810     |  
|Adjustments required to reconcile net
  income (loss) to net cash provided by (used in) operating activities: |  |                         |        |      |   |         |   |   |         |  
|                                                                                                             
|Loss from discontinued operations                                                                             |  |                         | 121    |      |   | 156     |   |   | 128     |  
|Depreciation and amortization                                                                                 |  |                         | 1,966  |      |   | 1,964   |   |   | 2,155   |  
|Loss (gain) on sale of property and
  equipment                                                               |  |                         | (18    | )    |   | (10     | ) |   | 7       |  
|Decrease (increase) in accrued interest on
  marketable securities, short-term and long-term bank deposits    |  |                         | 657    |      |   | (322    | ) |   | 293     |  
|Accrued interest and exchange rate changes
  of long-term loans                                               |  |                         | -      |      |   | -       |   |   | (58     | )
|Amortization of deferred stock
compensation                                                                   |  |                         | 184    |      |   | 439     |   |   | 51      |  
|Decrease (increase) in trade receivables,
  net                                                               |  |                         | 3,956  |      |   | (8,998  | ) |   | (3,956  | )
|Decrease (increase) in unbilled accounts
  receivable                                                         |  |                         | (4,130 | )    |   | (2,819  | ) |   | 3,482   |  
|Decrease (increase) in other accounts
  receivable and prepaid expenses                                       |  |                         | 16     |      |   | (599    | ) |   | 533     |  
|Decrease (increase) in deferred income
  taxes                                                                |  |                         | 178    |      |   | (1,020  | ) |   | (134    | )
|Decrease (increase) in inventories                                                                            |  |                         | (552   | )    |   | 1,676   |   |   | (2,728  | )
|Decrease (increase) in long-term trade
  receivables                                                          |  |                         | (44    | )    |   | 54      |   |   | 66      |  
|Increase (decrease) in trade payables                                                                         |  |                         | (1,953 | )    |   | 3,096   |   |   | (681    | )
|Increase in other accounts payable and
  accrued expenses                                                     |  |                         | 880    |      |   | 2,194   |   |   | 741     |  
|Increase (decrease) in customer advances                                                                      |  |                         | -      |      |   | 3,990   |   |   | (2,760  | )
|Accrued severance pay, net                                                                                    |  |                         | (2     | )    |   | 31      |   |   | 60      |  
|Award granted by principal shareholders                                                                       |  |                         | 1,200  |      |   | -       |   |   | -       |  
|Unrealized losses (gains) on hedging
  forward contract                                                       |  |                         | 476    |      |   | (441    | ) |   | 431     |  
|                                                                                                              |  |                         |        |      |   |         |  
|                                                                                                             
|Net cash provided by (used in) continuing
  operations                                                        |  |                         | 3,988  |      |   | (3,820  | ) |   | (1,560  | )
|Net cash provided by (used in) discontinued
  operations                                                      |  |                         | (310   | )    |   | (319    | ) |   | 184     |  
|                                                                                                              |  |                         |        |      |   |         |  
|                                                                                                             
|Net cash provided by (used in) operating
  activities                                                         |  |                         | 3,678  |      |   | (4,139  | ) |   | (1,376  | )
|                                                                                                              |  |                         |        |      |   |         |  
|                                                                                                             
|Cash flows from investing activities:                                                                         |  |                         |        |      |   |         |   |   |         |  
|                                                                                                             
|Purchase of short-term deposits                                                                               |  |                         | -      |      |   | (16,731 | ) |   | (13,726 | )
|Proceeds from sale of short-term bank
  deposits                                                              |  |                         | 8,400  |      |   | -       |   |   | 13,645  |  
|Purchase of long-term bank deposits                                                                           |  |                         | (3,000 | )    |   | -       |   |   | (3,000  | )
|Proceeds from sale of long-term deposits                                                                      |  |                         | -      |      |   | 1,194   |   |   | 3,000   |  
|Purchase of marketable securities                                                                             |  |                         | -      |      |   | -       |   |   | (8,219  | )
|Proceeds from sale of marketable
securities                                                                   |  |                         | -      |      |   | -       |   |   | 5,202   |  
|Redemption of structured notes                                                                                |  |                         | -      |      |   | 3,000   |   |   | -       |  
|Investment in long-term loan                                                                                  |  |                         | -      |      |   | -       |   |   | (622    | )
|Proceeds from sale of property and
  equipment                                                                |  |                         | 59     |      |   | 71      |   |   | 215     |  
|Purchase of property and equipment                                                                            |  |                         | (4,858 | )    |   | (2,736  | ) |   | (1,420  | )
|Purchase of know-how and patents                                                                              |  |                         | (89    | )    |   | (46     | ) |   | (323    | )
|                                                                                                              |  |                         |        |      |   |         |  
|                                                                                                             
|Net cash provided by (used in) investing
  activities                                                         |  |                         | 512    |      |   | (15,248 | ) |   | (5,248  | )
|                                                                                                              |  |                         |        |      |   |         |  

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

F  7

---

---



MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARTIES


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

|                                                               |  |                         |        |      |   |        |   |   |        |  
|-------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                               |  | Year ended December 31,
|                                                               |  |                         |       
|                                                               |  | 2004                    |        | 2005 |   | 2006   |  
|                                                               |  |                         |        |      |   |        |  
|Cash flows
  from financing activities:                        |  |                         |        |      |   |        |  
|                                                              
|Short-term bank credit, net                                    |  |                         | 2,895  |      |   | 2,402  |   |   | (1,369 | )
|Proceeds from long-term bank loans                             |  |                         | -      |      |   | 1,800  |   |   | 3,200  |  
|Principal payment of long-term bank loans                      |  |                         | (365   | )    |   | (1,849 | ) |   | (306   | )
|Proceeds from exercise of employee stock
  options             |  |                         | 967    |      |   | -      |   |   | 163    |  
|Proceeds from issuance of shares, net                          |  |                         | -      |      |   | 14,916 |   |   | -      |  
|Dividend paid                                                  |  |                         | (401   | )    |   | -      |   |   | -      |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Net cash provided by financing activities                      |  |                         | 3,096  |      |   | 17,269 |   |   | 1,688  |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Effect of exchange rate changes on cash and
  cash equivalents |  |                         | 289    |      |   | 253    |   |   | (255   | )
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Increase (decrease) in cash and cash
  equivalents             |  |                         | 7,575  |      |   | (1,865 | ) |   | (5,191 | )
|Cash and cash equivalents at the beginning
  of the year       |  |                         | 4,389  |      |   | 11,964 |   |   | 10,099 |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Cash and cash equivalents at the end of the
  year             |  | $                       | 11,964 |      | $ | 10,099 |   | $ | 4,908  |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Supplemental disclosures of cash flows
  activities:           |  |                         |        |      |   |        |   |   |        |  
|                                                              
|(a) Cash paid during the year for:                             |  |                         |        |      |   |        |   |   |        |  
|Interest                                                       |  | $                       | 1,093  |      | $ | 828    |   | $ | 1,518  |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|Income taxes                                                   |  | $                       | 1,164  |      | $ | 887    |   | $ | 1,486  |  
|                                                               |  |                         |        |      |   |        |  
|                                                              
|(b) Non-cash activities:                                       |  |                         |        |      |   |        |   |   |        |  
|Purchase
  of know-how                                         |  | $                       | -      |      | $ | -      |   | $ | 430    |  
|                                                               |  |                         |        |      |   |        |  

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

F  8

---

---



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
|            |        
|            | a.      | Magal
  Security Systems Ltd. (the Company) and its subsidiaries (together - the
  Group) are engaged in the development, manufacture, marketing and sale of
  complex computerized security systems used to automatically detect and deter
  human intrusion for both civilian and military markets. A majority of the
  Groups sales are generated in the U.S., Canada, Europe, Mexico and Israel.                                  
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | As for major
  customer data, see Note 16b.                                                                                                                                                                                                                                                                                                                                                                                                
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            | b.      | Award
  granted by principal shareholders:                                                                                                                                                                                                                                                                                                                                                                                                 
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |         | In June 2004, two principal shareholders of
  the Company awarded the Groups employees an award in the net amount of $1,200.
  The award was allocated among the employees according to their position and
  seniority. The Group recorded the award expense against additional paid-in
  capital in accordance with Staff Accounting Bulletin (SAB) Topic 5T,
  Accounting for Expenses or Liabilities Paid by Principal Stockholder.

|            |                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES                                                                                                                      
|            |                                                                                                                                                      
|            | The
  consolidated financial statements have been prepared in accordance with
  United States generally accepted accounting principles (U.S. 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 affect the amounts reported in the financial statements and accompanying
  notes. Actual results could differ from those estimates.                                                                                                                                                                                                                                                                                                                               
|            |                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | b.                                                                                                                                                    | Financial
  statements in U.S. dollars:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                       | Statement of
  the Financial Accounting Standards Board (SFAS) No. 52, Foreign Currency
  Translation sets the standards for translating foreign currency financial
  statements of consolidated subsidiaries. The first step in the translation
  process is to identify the functional currency for each entity included in
  the financial statements. The accounts of each entity are then remeasured
  in its functional currency. All transaction gains and losses from the
  remeasurement of monetary balance sheet items are reflected in the statement
  of operations as financial income or expenses, as appropriate.
|            |                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                       | After the
  remeasurement process is complete the financial statements are translated
  into the reporting currency, which is the U.S. dollar (dollar), using the
  current rate method. Equity accounts are translated using historical exchange
  rates. All other balance sheet accounts are translated using the exchange
  rates in effect at the balance sheet date. Statement of operations amounts
  have been translated using the average exchange rate for the year. The
  resulting translation adjustments are reported as a component of
  shareholders equity in accumulated other comprehensive income (loss).      
|            |                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                       | In
  accordance with U.S. Securities and Exchange Commission Regulation S-X 3-20
  (SX 3-20), the Company has determined its reporting currency to be the
  dollar. The measurement process of SX 3-20 is conceptually consistent with
  that of SFAS 52.                                                                                                                                                                                                                                                                                                                                                                            

F  9

---

---



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.)
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | The Company
  has determined that as of October 1, 2006 its functional currency has changed
  from the dollar to the New Israeli Shekel (NIS). Translation adjustments
  resulting from translating the Companys financial statements from the NIS to
  the dollar are reported as a separate component in shareholders equity.                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | c.                                      | Principles
  of consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | The
  consolidated financial statements include the accounts of the Company and its
  subsidiaries. Intercompany transactions and balances including profits from
  intercompany sales not yet realized outside the Company, have been eliminated
  upon consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | d.                                      | Cash
  equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | Cash
  equivalents are short-term highly liquid investments that are readily
  convertible into cash with original maturities of three months or less at the
  date acquired.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | e.                                      | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | The Company
  accounts for investments in debt securities in accordance with Statement of
  Financial Accounting Standard 115, Accounting for Certain Investments in
  Debt and Equity Securities (FAS 115). Management determines the
  appropriate classification of its investments in debt and equity securities
  at the time of purchase and reevaluates such determinations at each balance
  sheet date. The debt securities are classified as available-for-sale since
  the Company does not have the intent to hold the securities to maturity, and
  are stated at fair value. Available-for-sale securities are carried at fair
  value with unrealized gains, and are reported as a separate item under other
  comprehensive loss.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | f.                                      | Short-term
  and long-term bank deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | Short-term
  bank deposits are deposits with maturities of more than three months and less
  than one year, and presented at their cost.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | A bank deposit
  with maturities of more than one year is included in long-term bank deposits,
  and presented at cost.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | g.                                      | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | Inventories
  are stated at the lower of cost or market value. The Group periodically
  evaluates the quantities on hand relative to historical and projected sales
  volumes, current and historical selling prices and contractual obligations to
  maintain certain levels of parts. Based on these evaluations, inventory
  write-offs are provided to cover risks arising from slow-moving items, discontinued
  products, excess inventories, market prices lower than cost and adjusted
  revenue forecasts.                                                                                                                                                                                                                                      

F  10

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | Cost is determined as
  follows:                                                                                                                                                                                                
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | Raw materials, parts and
  supplies - using the first-in, first-out method.                                                                                                                                                   
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | Work in progress and
  finished products - on the basis of direct manufacturing costs with the
  addition of allocable indirect manufacturing costs.                                                                            
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | During 2004, 2005 and
  2006, the Group recorded inventory write-offs from continued operations in
  the amount of $ 218, $ 420 and $ 760, respectively. Such write-offs were
  included in cost of revenues.                   
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | During 2004, 2005 and
  2006, the Group recorded inventory write-off from discontinued operations in
  the amount of $ 6, $ 87 and $ 62, respectively. Such write-off were included
  in loss from discontinued operations, net.
|              |                                           |                                                                                                                                                                                                                                 
|              | h.                                        | Long-term trade
  receivables:                                                                                                                                                                                                  
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | Long-term trade
  receivables derive from operating lease arrangements and from long-term
  payment arrangements.                                                                                                               
|              |                                           |                                                                                                                                                                                                                                 
|              | i.                                        | Property and equipment:                                                                                                                                                                                                         
|              |                                           |                                                                                                                                                                                                                                 
|              |                                           | Property and equipment are
  stated at cost, net of accumulated depreciation. Depreciation is calculated
  by the straight-line method over the estimated useful lives of the assets at
  the following annual rates:           

| |                                                                                                          |  |                                     | 
| | -------------------------------------------------------------------------------------------------------- |  | ----------------------------------- | 
| |                                                                                                          |  | %                                   | 
| |                                                                                                          |  |                                     | 
| |                                                                                                          |  |                                     | 
| | Buildings                                                                                                |  | 3 - 4                               | 
| | Machinery and equipment (including machinery and equipment leased to
  customers under operating leases) |  | 10
  - 33 (mainly 10%)              | 
| | Motor vehicles                                                                                           |  | 15 - 33                             | 
| | Promotional displays                                                                                     |  | 25
  - 50                           | 
| | Office furniture and equipment                                                                           |  | 6
  - 33                            | 
| | Leasehold improvements                                                                                   |  | By
  the shorter of the term of the | 
| |                                                                                                          |  | lease
  or the life of the assets   | 
| |                                                                                                          |  |                                     | 
| |                                                                                                          | 

| |    |                                                                                                                                                                                                                                                                                                              
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | j. | Intangible assets:                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                              
| |    | Intangible assets are
  amortized over their useful lives 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 SFAS No. 142, Goodwill
  and Other Intangible Assets (SFAS No. 142).
| |    |                                                                                                                                                                                                                                                                                                              
| |    | Know-how is amortized over
  5 to 10 years, patents are amortized over a period of 10 years, customer list
  is amortized over an average period of three years and technology is
  amortized over 8 years.                                                                                                  

F  11

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | k.                                        | Impairment of long-lived
  assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                           | The Groups long-lived
  assets and certain identifiable intangibles are reviewed for impairment in
  accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
  Long-Lived Assets whenever events or changes in circumstances indicate that
  the carrying amount of a group of assets may not be recoverable.
  Recoverability of a group of assets to be held and used is measured by a
  comparison of the carrying amount of the group to the future undiscounted
  cash flows expected to be generated by the group. If such group of assets is
  considered to be impaired, the impairment to be recognized is measured by the
  amount by which the carrying amount of the assets exceeds their fair value.
  During 2004, 2005 and 2006, no impairment losses have been identified.                                                                                                                                                                 
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | l.                                        | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                           | Goodwill represents excess
  of the costs over the net fair value of the assets of the businesses
  acquired. SFAS No. 142 requires goodwill to be tested for impairment at least
  annually or between annual tests in certain circumstances, and written down
  when impaired, rather than being amortized. 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. Significant estimates used in the methodologies
  include estimates of future cash flows, future short-term and long-term
  growth rates and weighted average cost of capital for each of the reportable
  units. During 2004, 2005 and 2006, no impairment losses have been identified.                                                                                                                                                     
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                           | Differences between the
  balance of goodwill as of December 31, 2005 and 2006 derive from functional
  currency translation adjustments. The entire goodwill balance relates to the
  Perimeter security systems segment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | m.                                        | Revenue recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                           | The Group generates its
  revenues mainly from (1) installation of comprehensive security systems for
  which revenues are generated from long-term fixed price contracts; (2) sales
  of security products; and (3) services and maintenance, which are performed
  either on a fixed-price basis or as time-and-materials based contracts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                           | Revenues from installation
  of comprehensive security systems are generated from fixed-price contracts
  according to which the time between the signing of the contract and the final
  customer acceptance is usually over one year. Such contracts require
  significant customization for each customer specific needs and, as such,
  revenues from these type of contracts are recognized in accordance with
  Statement of Position (SOP) No. 81-1, Accounting for Performance of
  Construction-Type and Certain Production-Type Contracts, using contract
  accounting on a percentage of completion method. Accounting for long-term
  contracts using the percentage-of-completion method stipulates that revenue
  and expense are recognized throughout the life of the contract, even though
  the project is not completed and the purchaser does not have possession of
  the project. Percentage of completion is calculated based on the Input
  Method.

F  12

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | Project costs include
  materials purchased to produce the system, related labor and overhead
  expenses and subcontractors costs. The percentage to completion is measured
  by monitoring costs and efforts devoted using records of actual costs
  incurred to date in the project compared to the total estimated project
  requirement, which corresponds to the costs related to earned revenues. The
  amounts of revenues recognized are based on the total fees under the
  agreements and the percentage to completion achieved. 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. 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | 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 operations
  when they are reasonably determinable by management, on a cumulative catch-up
  basis.                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | The Group believes that
  the use of the percentage of completion method is appropriate as the Group
  has the ability to make reasonably dependable estimates of the extent of
  progress towards completion, contract revenues and contract costs. In
  addition, contracts executed include provisions that clearly specify the
  enforceable rights regarding services to be provided and received by the
  parties to the contracts, the consideration to be exchanged and the manner
  and the terms of settlement, including in cases of terminations for
  convenience. In all cases the Group expects to perform its contractual
  obligations and its customers are expected to satisfy their obligations under
  the contract.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | Fees are payable upon
  completion of agreed upon milestones and subject to customer acceptance.
  Amounts of revenues recognized in advance of contractual billing, are
  recorded as unbilled accounts receivable. The period between most instances
  of advanced recognition of revenues and the customers billing generally
  ranges between one to six months.                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | The Group sells security
  products to customers according to customers orders without installation
  work. The customers are not entitled to return the products. Revenues from
  security product sales are recognized in accordance with Staff Accounting
  Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements, when
  delivery has occurred, persuasive evidence of an agreement exists, the
  vendors fee is fixed or determinable, no further obligation exists and
  collectibility is probable.                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | Services and maintenance
  are performed under either fixed-price based or time-and-materials based
  contracts. Under fixed-price contracts, the Group agrees to perform certain
  work for a fixed price. Under time-and-materials contracts, the Group is
  reimbursed for labor hours at negotiated hourly billing rates and for
  materials. Such service contracts are not in the scope of SOP No. 81-1, and
  accordingly, related revenues are recognized in accordance with SAB No. 104,
  as those services are performed or over the term of the related agreements
  provided that, an evidence of an arrangement has been obtained, fees are
  fixed and determinable and collectibility is reasonably assured.             

F  13

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | One of the Companys
  subsidiaries provides security video monitoring services. The majority of its
  contracts are for a five year term and do not include terms that result in
  the transfer of title of the equipment to the customer. Under the contracts
  service is not dependent on specific equipment. The subsidiarys obligation
  is related to the provision of monitoring services. In accordance with
  Emerging Issues Task Force (EITF) No. 01-08, Determining Whether an
  Arrangement Contains a Lease and SFAS No. 13, Accounting for Leases, the
  service contract does not meet the definition of a lease and as such the
  subsidiary recognizes monthly service fees over the term of the agreement.                                                                                                              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Deferred revenue includes
  unearned amounts under installation services, service contracts and
  maintenance agreements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | n.                                        | Accounting for stock-based
  compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | On January 1, 2006, the
  Company adopted Statement of Financial Accounting Standards No. 123 (revised
  2004), Share-Based Payment (SFAS 123(R)) which requires the measurement
  and recognition of compensation expense based on estimated fair values for
  all share-based payment awards made to employees and directors. SFAS 123(R)
  supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock
  Issued to Employees (APB 25), under which the Company previously accounted
  for its share based awards granted to employees and directors, for periods
  beginning in fiscal 2006. In March 2005, the Securities and Exchange
  Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to
  SFAS 123(R). The Company has applied the provisions of SAB 107 in its
  adoption of SFAS 123(R).
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | SFAS 123(R) requires
  companies to estimate the fair value of equity-based payment awards on the
  date of grant using an option-pricing model. The value of the portion of the
  award that is ultimately expected to vest is recognized as an expense over
  the requisite service periods in the Companys consolidated income statement.
  Prior to the adoption of SFAS 123(R), the Company accounted for equity-based
  awards to employees and directors using the intrinsic value method in
  accordance with APB 25 as allowed under Statement of Financial Accounting
  Standards No. 123, Accounting for Stock-Based Compensation (SFAS
  123).                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The Company adopted SFAS
  123(R) using the modified prospective transition method, which requires the
  application of the accounting standard starting from January 1, 2006, the
  first day of the Companys fiscal year 2006. Under that transition method,
  compensation cost recognized in 2006, includes only compensation cost for all
  share-based payments granted prior to, but not yet vested as of January 1,
  2006, based on the grant date fair value estimated in accordance with the
  original provisions of Statement 123. The Company did not grant stock options
  in 2006. Results for prior periods have not been restated.                                                                                                                                                                                              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The Company recognizes
  compensation expenses for the value of its awards, which have graded vesting,
  based on the accelerated attribution method over the vesting period, net of
  estimated forfeitures. Estimated forfeitures are based on actual historical
  pre-vesting forfeitures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F  14

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | As a result of adopting
  SFAS 123(R) on January 1, 2006, the Companys net income for the year ended
  December 31, 2006, is approximately $ 15 lower than if it had continued to
  account for stock-based compensation under APB 25. The influence on the basic
  and diluted net earnings per share for the year ended December 31, 2006 is
  immaterial.                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | Prior to January 1, 2006,
  the Company applied the intrinsic value method of accounting for stock
  options as prescribed by APB 25, whereby compensation expense is equal to the
  excess, if any, of the quoted market price of the stock over the exercise
  price at the grant date of the award.                                                                        
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | During the years ended
  December 31, 2004, 2005 and 2006, the Company recognized stock-based
  compensation expenses related to employee stock options in the amounts of $
  184, $ 439 and $ 51, respectively.                                                                                                                                                              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | The Company estimates the
  fair value of stock options granted using the Black-Scholes-Merton
  option-pricing model. The option-pricing model requires a number of
  assumptions, of which the most significant are expected stock price
  volatility and the expected option term. Expected volatility was calculated
  based upon actual historical stock price movements.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | The expected option term
  represents the period that the Companys stock options are expected to be
  outstanding. The risk-free interest rate is based on the yield from U.S.
  Treasury zero-coupon bonds with an equivalent term. The Company has no
  foreseeable plans to pay dividends.                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           | Fair values were estimated
  using the following weighted average assumptions:                                                                                                                                                                                                                                                                                                

| |                        |  |             |  |             |    |  | 
| | ---------------------- |  | ----------- |  | ----------- | -- |  | 
| |                        |  | 2004        |  | 2005        |   
| |                        |  |             |  |             |   
| | Dividend yield         |  | 0%          |  |             | 0% |  | 
| | Expected volatility    |  | 97.9%       |  | 83.4%       |   
| | Risk-free interest     |  | 2.46%       |  | 4%          |   
| | Expected life of up to |  | 1.5
  years |  | 2.5
  years |   

| |  |                                                   
| |  | --------------------------------------------------
| |  | The Company did not grant
  stock options in 2006.

F  15

---

---



|                                                           
|-----------------------------------------------------------
|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.)
|            |                                        
|            |                                         | A summary of
  employee option activity under the Companys stock option plans as of
  December 31, 2006 and changes during the year ended December 31, 2006 are as
  follows:

| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| | ------------------------------------------------ |  | ------------------- | ------- | - | ------------------------------------ | - | ---- | ---------------------------------------------------------------- |  | -------------------------------------------- | ---- |  | - | --- | 
| |                                                  |  | Number of
  options |         |   | Weighted-
  average
  exercise price |   |      | Weighted-
  average
  remaining
  contractual life
  (in months) |  | Aggregate
  intrinsic value
  (in thousands) |     
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |     
|
| | Outstanding at January 1, 2006                   |  |                     | 343,000 |   |                                      | $ | 8.35 |                                                                  |  |                                              |      |  |   |     | 
| | Granted                                          |  |                     | -       |   |                                      | $ | -    |                                                                  |  |                                              |      |  |   |     | 
| | Exercised                                        |  |                     | (19,100 | ) |                                      | $ | 8.56 |                                                                  |  |                                              |      |  |   |     | 
| | Forfeited                                        |  |                     | (1,800  | ) |                                      | $ | 8.56 |                                                                  |  |                                              |      |  |   |     | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| | Outstanding at December 31, 2006                 |  |                     | 322,100 |   |                                      | $ | 8.34 |                                                                  |  |                                              | 40.3 |  | $ | 218 | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| | Exercisable at December 31, 2006                 |  |                     | 317,100 |   |                                      | $ | 8.26 |                                                                  |  |                                              | 40.1 |  | $ | 218 | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 
| | Vested and expected to vest at December 31, 2006 |  |                     | 322,100 |   |                                      | $ | 8.34 |                                                                  |  |                                              | 40.3 |  | $ | 218 | 
| |                                                  |  |                     |         |   |                                      |   |      |                                                                  |  |                                              |      |  |   |     | 

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The
  weighted-average grant-date fair value of options granted during the years
  ended December 31, 2004 and 2005 was $7.92 and $4.39, respectively. The
  aggregate intrinsic value in the table above represents the total intrinsic
  value (the difference between the Companys closing stock price on the last
  trading day of the fourth quarter of fiscal 2006 and the exercise price,
  multiplied by the number of in-the-money options) that would have been
  received by the option holders had all option holders exercised their options
  on December 31, 2006. This amount changes based on the fair market value of
  the Companys stock. Total intrinsic value of options exercised for the year
  ended December 31, 2006 was approximately $71. As of December 31, 2006, there
  was approximately $13 of total unrecognized compensation costs related to
  non-vested share-based compensation arrangements granted under the Companys
  stock option plans. That cost is expected to be recognized over a
  weighted-average period of 0.97 years. Total grant-date fair value of options
  that vested during the year ended December 31, 2006 was approximately $713.

F  16

---

---



|                                                           
|-----------------------------------------------------------
|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.)
|            |                                        
|            |                                         | The
  following table illustrates the effect on the net income (loss) and net
  earnings (loss) per share, assuming that the Company had applied the fair
  value recognition provision of SFAS 123 on its stock-based employee
  compensation for all prior periods:

| |                                                                                                                                  |  |                           |       |      |   |        |  
| | -------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ----- | ---- | - | ------ | -
| |                                                                                                                                  |  | Year ended
  December 31, |      
| |                                                                                                                                  |  |                           |      
| |                                                                                                                                  |  | 2004                      |       | 2005 |  
| |                                                                                                                                  |  |                           |       |      |  
|
| | Net income (loss) as reported:                                                                                                   |  | $                         | 1,053 |      | $ | (3,211 | )
| | Add: stock-based compensation expenses
  determined under the intrinsic value based method included in the reported
  net income |  |                           | 184   |      |   | 439    |  
| | Deduct: stock-based compensation expenses
  determined under fair value based method for all awards                              |  |                           | (198  | )    |   | (1,493 | )
| |                                                                                                                                  |  |                           |       |      |   |        |  
|
| | Pro forma net income                                                                                                             |  | $                         | 1,039 |      | $ | (4,265 | )
| |                                                                                                                                  |  |                           |       |      |   |        |  
|
| | Basic net earnings (loss) per share, as
  reported                                                                               |  | $                         | 0.12  |      | $ | (0.32  | )
| |                                                                                                                                  |  |                           |       |      |   |        |  
|
| | Diluted net earnings (loss) per share, as
  reported                                                                             |  | $                         | 0.12  |      | $ | (0.32  | )
| |                                                                                                                                  |  |                           |       |      |   |        |  
|
| | Pro forma basic net earnings (loss) per
  share                                                                                  |  | $                         | 0.12  |      | $ | (0.43  | )
| |                                                                                                                                  |  |                           |       |      |   |        |  
|
| | Pro forma diluted net earnings (loss) per
  share                                                                                |  | $                         | 0.12  |      | $ | (0.43  | )
| |                                                                                                                                  |  |                           |       |      |   |        |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | o. | Research and
  development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | Research and
  development costs incurred in the process of developing product improvements
  or new products, are charged to expenses as incurred, net of grants received
  and investment tax credit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | p. | Warranty
  costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | The Group
  provides a warranty for up to 24 months, at no extra charge. The Group
  estimates the costs that may be incurred under its warranty and records a
  liability in the amount of such costs at the time product revenue is
  recognized in accordance with FASB interpretation (FIN) No. 45,
  Guarantors Accounting and Disclosure Requirements for Guarantees, Including
  Indirect Guarantees of Indebtedness of Others and SFAS No. 5, Accounting
  for Contingencies. Factors that affect the Groups warranty liability include
  the number of units, historical and anticipated rates of warranty claims and
  cost per claim. The Group periodically assesses the adequacy of its recorded
  warranty liabilities and adjusts the amounts as necessary. A tabular
  reconciliation of the changes in the Groups aggregate product warranty
  liability is not provided due to immateriality.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | q. | 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 reduction of
  research and development costs. Research and development grants recognized
  amounted to $228, $8 and $0 in 2004, 2005 and 2006, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F  17

---

---



|                                                           
|-----------------------------------------------------------
|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.)
|            |                                        
|            | r.                                      | Net earnings
  (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Basic net
  earnings (loss) per share is computed based on the weighted average number of
  Ordinary shares outstanding during each year. Diluted net earnings (loss) 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 SFAS No. 128 ,
  Earnings Per Share.                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | s.                                      | Concentrations
  of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Financial
  instruments that potentially subject the Group to concentrations of credit
  risk consist principally of cash and cash equivalents, marketable securities,
  short-term and long-term bank deposits, trade receivables, unbilled accounts
  receivable, , long-term trade receivables and long-term loan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Cash and
  cash equivalents, short-term and long-term bank deposits are mainly invested
  in major Israeli and U.S. banks. Cash and cash equivalents in the United
  States may be in excess of insured limits and are not insured in other jurisdictions.
  Management believes that the financial institutions that hold the Groups
  investments are financially sound and, accordingly, minimal credit risk
  exists with respect to these investments.                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Marketable
  securities comprised of investments in U.S. government debentures. Management
  believes that the U.S. government is financially sound, and accordingly
  minimal credit risk exists with respect to these marketable securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The
  short-term and long-term trade receivables of the Group, as well as the
  unbilled accounts receivable, are derived from sales to large and solid
  organizations and governmental authorities located mainly in Israel, the
  United States, Canada, Mexico and Europe. The Group performs ongoing credit
  evaluations of its customers and to date have not experienced any material
  losses. An allowance for doubtful accounts is determined with respect to
  those amounts that the Group has determined to be doubtful of collection and
  in accordance with an aging key. During the years ended December 31, 2004,
  2005 and 2006, the group recorded $131, $(13) and $187 of expenses related to
  doubtful accounts, respectively. In certain circumstances, the Group may
  require letters of credit, other collateral or additional guarantees.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The loan granted
  to a third party is secured by personal guarantee of the beneficial owner
  (see Note 11i). The management believes that the loan is well secured, and
  accordingly, minimal credit risk exists with respect to this loan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The Group
  has no significant off-balance sheet concentration of credit risks, such as
  foreign exchange contracts or foreign hedging arrangements, except derivative
  instruments, which are detailed in x. below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

F  18

---

---



|                                                           
|-----------------------------------------------------------
|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.                                      | Income
  taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | The Group
  accounts for income taxes in accordance with SFAS No. 109, Accounting for
  Income Taxes. 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 Group provides
  a valuation allowance, if necessary, to reduce deferred tax assets to their
  estimated realizable value.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | u.                                      | Severance
  pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | The
  Companys liability for its Israeli employees severance pay is calculated
  pursuant to Israels 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 include profits accumulated up to balance sheet date. The
  deposited funds may be withdrawn only upon the fulfillment of the obligation
  pursuant to Israels 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, 2004, 2005 and 2006, amounted to
  approximately $306, $362 and $476, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | v.                                      | Fair value
  of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | The
  following methods and assumptions were used by the Group in estimating its
  fair value disclosures for financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         | (i)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | The carrying
  amounts of cash and cash equivalents, marketable securities, short-term bank
  deposits, trade receivables, unbilled accounts receivable, short-term bank
  credit and trade payables approximate their fair value due to the short-term
  maturity of such instruments.                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         | (ii)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | The carrying
  amount of the Groups long-term trade receivables and long-term bank deposits
  approximate their fair value. The fair value was estimated using discounted
  cash flows analyses, based on the Groups investment rates for similar type
  of investment arrangements.                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         | (iii)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | The carrying
  amounts of the Groups long-term debt are estimated by discounting the future
  cash flows using current interest rates for loans of similar terms and
  maturities. As of December 31, 2005, the fair value of the Companys
  long-term borrowing was $5,259, compared to the carrying amount of $5,300. As
  of December 31, 2006, the fair value of the Companys long-term borrowing was
  $8,158, compared to the carrying amount of $8,194.

F  19

---

---



|                                                           
|-----------------------------------------------------------
|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.                                      | Advertising
  expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | Advertising
  costs are expensed as incurred. Advertising expenses for the years ended
  December 31, 2004, 2005 and 2006, were $495, $420 and $447, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | x.                                      | Derivative
  instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | SFAS No.
  133, Accounting for Derivative Instruments and Hedging Activities, requires
  a company to recognize all of its derivative instruments as either assets or
  liabilities in the statement of financial position at fair value. The
  accounting for changes in the fair value (i.e., gains or losses) of a
  derivative instrument depends on whether it has been designated and qualifies
  as part of a hedging relationship and further, on the type of hedging
  relationship. For those derivative instruments that are designated and
  qualify as hedging instruments, a company must designate the hedging
  instrument, based upon the exposure being hedged.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | To protect
  against the change in the forecasted foreign currency cash flows of certain
  sale arrangements resulting from changes in the exchange rate, the Company
  has entered during 2004, 2005 and 2006 into forward contracts in order to
  hedge portions of its forecasted revenue and unbilled accounts receivable
  denominated in Euros and Polish Zlotys. The Company has designated the
  forward instruments as cash flow hedges for accounting purposes.                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | For
  derivative instruments designated as cash flow hedge (i.e., hedging the
  exposure to variability in expected future cash flows that is attributable to
  a particular risk), the effective portion of the gain or loss on the
  derivative instrument is reported as a component of other comprehensive
  income and reclassified into earnings in the same line item associated with
  the forecasted transaction in the same period or periods during which the
  hedged transaction affects earnings.                                                                                                                                                                    
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The Company
  determined that it is probable that sales arrangement in Polish Zlotys and
  the related forecasted revenues and accounts receivable will not occur by the
  end of the specified time period. Accordingly, changes in the fair value of
  the forward contracts were recorded in financial expenses in the years ended
  December 31, 2005 and 2006.                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | On October
  1, 2006, the Company changed its functional currency from dollars to NIS (see
  also Note 2b). From the date of change in functional currency, the hedge of
  the revenues in Euros is no longer effective. Changes in the fair value of
  the forward contracts from October 1, 2006 were charged to financial
  expenses.                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The Company
  recorded $0, $110 and $915 as financial expenses related to forward contracts
  transactions, in 2004, 2005 and 2006, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

F  20

---

---



|                                                           
|-----------------------------------------------------------
|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.)
|            |                                        
|            | y.                                      | Reclassification:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | Certain
  financial statement data for prior years have been reclassified to conform to
  current year financial statement presentation. The reclassification did not
  impact net income, working capital or cash flows from operations as
  previously reported.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            | z.                                      | Impact of
  recently issued Accounting Standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | In July
  2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes
  an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the
  accounting for income taxes by prescribing the minimum recognition threshold
  a tax position is required to meet before being recognized in the financial
  statements. FIN 48 utilizes a two-step approach for evaluating tax positions.
  Recognition (step one) occurs when an enterprise concludes that a tax
  position, based solely on its technical merits, is more-likely-than-not to be
  sustained upon examination. Measurement (step two) is only addressed if step
  one has been satisfied (i.e., the position is more-likely-than-not to be
  sustained). Under step two, the tax benefit is measured as the largest amount
  of benefit, determined on a cumulative probability basis that is
  more-likely-than-not to be realized upon ultimate settlement.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | FIN 48
  applies to all tax positions related to income taxes subject to the Financial
  Accounting Standard Board Statement No. 109, Accounting for Income Taxes
  (FAS 109). This includes tax positions considered to be routine as well
  as those with a high degree of uncertainty.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | FIN 48 has
  expanded disclosure requirements, which include a tabular roll forward of the
  beginning and ending aggregate unrecognized tax benefits as well as specific
  detail related to tax uncertainties for which it is reasonably possible the amount
  of unrecognized tax benefit will significantly increase or decrease within
  twelve months. These disclosures are required at each annual reporting period
  unless a significant change occurs in an interim period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | FIN 48 is
  effective for fiscal years beginning after December 15, 2006. The cumulative
  effect of applying FIN 48 will be reported as an adjustment to the opening
  balance of retained earnings. For the evaluation of the effect of the
  adoption of FIN 48 on the financial statements, see note 19.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         | In September
  2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No.
  157). This statement provides a single definition of fair value, a framework
  for measuring fair value, and expanded disclosures concerning fair value.
  Previously, different definitions of fair value were contained in various
  accounting pronouncements creating inconsistencies in measurement and
  disclosures. SFAS No. 157 applies under those previously issued
  pronouncements that prescribe fair value as the relevant measure of value,
  except SFAS No. 123(R) and related interpretations. The statements does not
  apply to accounting standard that require or permit measurement similar to
  fair value but are not intended to measure fair value. This pronouncement is
  effective for fiscal years beginning after November 15, 2007. The Company is
  currently evaluating the impact of adopting SFAS 157.                  

F  21

---

---



|                                                           
|-----------------------------------------------------------
|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 February
  2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
  Assets and Financial Liabilities (SFAS No. 159), which permits companies
  to choose to measure certain financial instruments and other items at fair
  value that are not currently required to be measured at fair value. SFAS No.
  159 is effective for fiscal years beginning after November 15, 2007. The
  Company will adopt SFAS No. 159 no later than January 1, 2008. The Company
  has not yet determined the effect that the adoption of SFAS No. 159 will have
  on its consolidated financial statements.
|            |                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|NOTE 3:    | MARKETABLE SECURITIES                                                                                                                                                     
|            |                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | The Company
  invests in marketable debt securities, which are classified as
  available-for-sale investments. The following is a summary of marketable debt
  securities:

| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 
| | ------------------------------------------------ |  | ---------------- | - | ------------------- | - | -------------- |  | ---------------- | - | ------------------- | - | -------------- |  | - | -- |  | - | ----- | 
| |                                                  |  | December 31,     |  
| |                                                  |  |                  |  
| |                                                  |  | 2005             |   | 2006                |  
| |                                                  |  |                  |   |                     |  
| |                                                  |  | Amortized
  cost |   | Unrealized
  losses |   | Market
  value |  | Amortized
  cost |   | Unrealized
  losses |   | Market
  value | 
| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                | 
| | Available-for-sale:                              |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 
| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 
| | U.S. Government debentures                       |  | $                | - |                     | $ | -              |  | $                | - |                     | $ | 3,080          |  | $ | 13 |  | $ | 3,067 | 
| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 
| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 
| | Total
  available-for-sale marketable securities |  | $                | - |                     | $ | -              |  | $                | - |                     | $ | 3,080          |  | $ | 13 |  | $ | 3,067 | 
| |                                                  |  |                  |   |                     |   |                |  |                  |   |                     |   |                |  |   |    |  |   |       | 

| |                                                                                                                                                                                                                                                                                                                                                                                         | 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | The
  unrealized losses on available-for-sale debt securities included in other
  comprehensive income, as a separate component of shareholders equity,
  totaled to $ 13 as of December 31, 2006.                                                                                                                                                                                    
| |                                                                                                                                                                                                                                                                                                                                                                                         | 
| | The
  unrealized losses on the Companys investments in available-for-sale
  securities are a result of interest rate changes. Since the Company has the
  ability and intent to hold these investments until a recovery of fair value,
  which may be until maturity, the Company does not consider these investments
  to be other-than-temporarily impaired as of December 31, 2006.
| |                                                                                                                                                                                                                                                                                                                                                                                         | 
| | The
  amortized cost and estimated fair value of available-for-sale investments as
  of December 31, 2006, by contractual maturity, are as follows:                                                                                                                                                                                                                                    

| |                                 |  |                  |   |                |   |                  |  |                |       |  |   |       | 
| | ------------------------------- |  | ---------------- | - | -------------- | - | ---------------- |  | -------------- | ----- |  | - | ----- | 
| |                                 |  | December 31,     |  
| |                                 |  |                  |  
| |                                 |  | 2005             |   | 2006           |  
| |                                 |  |                  |   |                |  
| |                                 |  | Amortized
  cost |   | Market
  value |   | Amortized
  cost |  | Market
  value |      
| |                                 |  |                  |   |                |   |                  |  |                |      
| | Available-for-sale:             |  |                  |   |                |   |                  |  |                |       |  |   |       | 
| | Matures in one year             |  | $                | - |                | $ | -                |  | $              | -     |  | $ | -     | 
| | Matures in one to three
  years |  |                  | - |                |   | -                |  |                | 3,080 |  |   | 3,067 | 
| |                                 |  |                  |   |                |   |                  |  |                |       |  |   |       | 
| |                                 |  |                  |   |                |   |                  |  |                |       |  |   |       | 
| |                                 |  | $                | - |                | $ | -                |  | $              | 3,080 |  | $ | 3,067 | 
| |                                 |  |                  |   |                |   |                  |  |                |       |  |   |       | 

F  22

---

---



|                                                           
|-----------------------------------------------------------
|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:    | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

|                         |  |              |       |      |   |       | 
|------------------------ |  | ------------ | ----- | ---- | - | ----- | 
|                         |  | December 31, |      
|                         |  |              |      
|                         |  | 2005         |       | 2006 |  
|                         |  |              |       |      |  
|                        
|Government
  authorities |  | $            | 1,585 |      | $ | 1,756 | 
|Employees                |  |              | 294   |      |   | 207   | 
|Prepaid
  expenses       |  |              | 653   |      |   | 495   | 
|Advances to
  suppliers  |  |              | 1,548 |      |   | 1,159 | 
|Others                   |  |              | 375   |      |   | 378   | 
|                         |  |              |       |      |   |       | 
|                        
|                         |  | $            | 4,455 |      | $ | 3,995 | 
|                         |  |              |       |      |   |       | 



|            |            
|----------- | -----------
|NOTE 5:    | INVENTORIES

|                    |  |   |        |  |   |        | 
|------------------- |  | - | ------ |  | - | ------ | 
|Raw
  materials     |  | $ | 4,902  |  | $ | 7,650  | 
|Work in
  progress  |  |   | 1,855  |  |   | 2,213  | 
|Finished
  products |  |   | 4,353  |  |   | 4,108  | 
|                    |  |   |        |  |   |        | 
|                   
|                    |  | $ | 11,110 |  | $ | 13,971 | 
|                    |  |   |        |  |   |        | 

|            |                       
|----------- | ----------------------
|NOTE 6:    | PROPERTY AND EQUIPMENT

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

|   |                                                                                                                                    |  |   |        |  |   |        | 
|-- | ---------------------------------------------------------------------------------------------------------------------------------- |  | - | ------ |  | - | ------ | 
|   | Cost:                                                                                                                              |  |   |        |  |   |        | 
|   | Land and buildings                                                                                                                 |  | $ | 8,949  |  | $ | 8,982  | 
|   | Machinery and equipment                                                                                                            |  |   | 7,092  |  |   | 6,775  | 
|   | Machinery and equipment leased to customers
  under operating leases                                                               |  |   | 7,949  |  |   | 8,352  | 
|   | Motor vehicles                                                                                                                     |  |   | 1,324  |  |   | 1,133  | 
|   | Promotional displays                                                                                                               |  |   | 1,244  |  |   | 1,121  | 
|   | Office furniture and equipment                                                                                                     |  |   | 3,190  |  |   | 2,985  | 
|   | Leasehold improvements                                                                                                             |  |   | 780    |  |   | 805    | 
|   |                                                                                                                                    |  |   |        |  |   |        | 
|  
|   |                                                                                                                                    |  |   | 30,528 |  |   | 30,153 | 
|   |                                                                                                                                    |  |   |        |  |   |        | 
|   | Accumulated depreciation:                                                                                                          |  |   |        |  |   |        | 
|   | Buildings                                                                                                                          |  |   | 2,698  |  |   | 3,144  | 
|   | Machinery and equipment                                                                                                            |  |   | 5,987  |  |   | 5,662  | 
|   | Machinery and equipment leased to customers
  under operating leases                                                               |  |   | 1,596  |  |   | 2,311  | 
|   | Motor vehicles                                                                                                                     |  |   | 954    |  |   | 896    | 
|   | Promotional displays                                                                                                               |  |   | 1,025  |  |   | 1,028  | 
|   | Office furniture and equipment                                                                                                     |  |   | 2,554  |  |   | 2,533  | 
|   | Leasehold improvements                                                                                                             |  |   | 127    |  |   | 213    | 
|   |                                                                                                                                    |  |   |        |  |   |        | 
|  
|   |                                                                                                                                    |  |   | 14,941 |  |   | 15,787 | 
|   |                                                                                                                                    |  |   |        |  |   |        | 
|  
|   | Depreciated cost                                                                                                                   |  | $ | 15,587 |  | $ | 14,366 | 
|   |                                                                                                                                    |  |   |        |  |   |        | 
|   |                                                                                                                                   
|b. | Depreciation
  expenses amounted to $1,822, $1,823 and $1,952 for the years ended December
  31, 2004, 2005 and 2006, respectively
|   |                                                                                                                                   
|c. | As for
  charges, see Note 11h.                                                                                                   

F  23

---

---



|                                                           
|-----------------------------------------------------------
|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:    | OTHER INTANGIBLE ASSETS, NET
|            |                             
|            | a.                           | Composition:

|                          |  |              |       |      |   |       | 
|------------------------- |  | ------------ | ----- | ---- | - | ----- | 
|                          |  | December 31, |      
|                          |  |              |      
|                          |  | 2005         |       | 2006 |  
|                          |  |              |       |      |  
|Cost:                     |  |              |       |      |   |       | 
|Know-how                  |  | $            | 502   |      | $ | 982   | 
|Patents                   |  |              | 2,787 |      |   | 2,859 | 
|Customer list             |  |              | -     |      |   | 172   | 
|Technology                |  |              | 436   |      |   | 436   | 
|                          |  |              |       |      |   |       | 
|                         
|                          |  |              | 3,725 |      |   | 4,449 | 
|                          |  |              |       |      |   |       | 
|Accumulated amortization: |  |              |       |      |   |       | 
|Know-how                  |  |              | 446   |      |   | 429   | 
|Patents                   |  |              | 2,575 |      |   | 2,626 | 
|Customer list             |  |              | -     |      |   | 53    | 
|Technology                |  |              | 135   |      |   | 191   | 
|                          |  |              |       |      |   |       | 
|                         
|                          |  |              | 3,156 |      |   | 3,299 | 
|                          |  |              |       |      |   |       | 
|                         
|Amortized cost            |  | $            | 569   |      | $ | 1,150 | 
|                          |  |              |       |      |   |       | 

|   |                                                                                     
|-- | ------------------------------------------------------------------------------------
|b. | Amortization
  expenses related to intangible assets amounted to $144, $141 and $203
|   | for the
  years ended December 31, 2004, 2005 and 2006, respectively.               
|   |                                                                                     
|c. | Estimated
  amortization of intangible assets for the years ended:                  

| |                       |  |   |       | 
| | --------------------- |  | - | ----- | 
| | December
  31,        |  |   |       | 
| |                       |  |   |       | 
| | 2007                  |  | $ | 238   | 
| | 2008                  |  |   | 204   | 
| | 2009                  |  |   | 196   | 
| | 2010                  |  |   | 165   | 
| | 2011 and
  thereafter |  |   | 347   | 
| |                       |  |   |       | 
|
| |                       |  | $ | 1,150 | 
| |                       |  |   |       | 

F  24

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|            |                        |                                                          
|----------- | ---------------------- | ---------------------------------------------------------
|NOTE 8:    | SHORT-TERM BANK CREDIT
|            |                       
|            | a.                     | Classified by currency, linkage terms and interest rates:



|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 
|-------------------------------------------------------- |  | ------------- | ---- | ------------ |  | ---- |  | ---- | ------ |  | - | ------ | 
|                                                         |  | Interest rate |      | December 31, | 
|                                                         |  |               |      |              | 
|                                                         |  | 2005          |      | 2006         |  | 2005 |  | 2006 |       
|                                                         |  |               |      |              |  |      |  |      |       
|                                                         |  | %             |      |              |  |      |  |      |       
|                                                         |  |               |      |              |  |      |  |      |       
|In or linked to U.S. dollars (1)                         |  |               | 4.14 |              |  | 5.71 |  | $    | 15,100 |  | $ | 13,600 | 
|In or linked to NIS (1)                                  |  |               | 5.00 |              |  | 5.85 |  |      | 1,742  |  |   | 3,426  | 
|In or linked to PLN (1)                                  |  |               | 5.92 |              |  | -    |  |      | 1,226  |  |   | -      | 
|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 
|                                                        
|                                                         |  |               |      |              |  |      |  | $    | 18,068 |  | $ | 17,026 | 
|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 
|Weighted average interest rates at the end
  of the year |  |               | 4.62 |              |  | 5.74 |  |      |        |  |   |        | 
|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 
|Total authorized credit lines approximate                |  |               |      |              |  |      |  | $    | 48,895 |  | $ | 54,841 | 
|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 
|                                                        
|Unutilized credit lines approximate                      |  |               |      |              |  |      |  | $    | 15,781 |  | $ | 21,437 | 
|                                                         |  |               |      |              |  |      |  |      |        |  |   |        | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Company
  has undertaken to maintain the following financial ratios and terms in
  respect of its used credit line:(i) a ratio of at least 40% of consolidated
  shareholders equity out of the consolidated total assets, (ii) minimal annual
  consolidated net income in the amount of $ 1,000 and (iii) the same
  shareholders maintain the core of control in the Company. As of December 31,
  2005 and 2006, the Company was not in compliance with the requirement under
  its credit lines that the Company will have a minimum annual consolidated net
  income of at least $ 1,000. Subsequent to the balance sheet date, the banks
  agreed to waive such requirement as of December 31, 2006 and informed the
  Company that it will not require the immediate repayment of the Companys
  outstanding indebtedness as a result of such non-compliance. In addition, the
  banks agreed to cancel the aforementioned ratios and terms.

| |    |                                
| | -- | -------------------------------
| | b. | As for
  charges, see Note 11h.

|            |                                            
|----------- | -------------------------------------------
|NOTE 9:    | OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

|                                                                    |  |              |       |      |   |       | 
|------------------------------------------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
|                                                                    |  | December 31, |      
|                                                                    |  |              |      
|                                                                    |  | 2005         |       | 2006 |  
|                                                                    |  |              |       |      |  
|Employees and payroll accruals                                      |  | $            | 1,596 |      | $ | 1,799 | 
|Provision in respect of demand for bank
  performance guarantee (1) |  |              | 1,436 |      |   | -     | 
|Accrued expenses                                                    |  |              | 4,859 |      |   | 5,743 | 
|Deferred revenues                                                   |  |              | 284   |      |   | 555   | 
|Government authorities                                              |  |              | 84    |      |   | 528   | 
|Income tax payable                                                  |  |              | 249   |      |   | 635   | 
|Others                                                              |  |              | 406   |      |   | 522   | 
|                                                                    |  |              |       |      |   |       | 
|                                                                   
|                                                                    |  | $            | 8,914 |      | $ | 9,782 | 
|                                                                    |  |              |       |      |   |       | 
|(1)      See also Note 11 g(2).                                     |  |              |       |      |   |       | 

F  25

---

---





|                                                           
|-----------------------------------------------------------
|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:   | LONG-TERM BANK DEBT
|            |                    
|            | a.                  | Classified by currency, linkage terms and interest rates:

| |                                                          |  |         |  |               |      |              |  |       |  |      |       |  |   |       | 
| | -------------------------------------------------------- |  | ------- |  | ------------- | ---- | ------------ |  | ----- |  | ---- | ----- |  | - | ----- | 
| |                                                          |  |         |  | Interest rate |      | December 31, | 
| |                                                          |  | Linkage |  |               |      |              | 
| |                                                          |  | terms   |  | 2005          |      | 2006         |  | 2005  |  | 2006 |      
| |                                                          |  |         |  |               |      |              |  |       |  |      |      
| |                                                          |  |         |  | %             |      |              |  |       |  |      |      
| |                                                          |  |         |  |               |      |              |  |       |  |      |      
| |                                                          |  |         |  |               |      |              |  |       |  |      |      
| | Bank loans                                               |  | U.S. $  |  |               | 3.10 |              |  | 5.96  |  | $    | 2,500 |  | $ | 5,540 | 
| | Bank
  promissory notes(1)                               |  | U.S. $  |  |               | 5.4  |              |  | 6.215 |  |      | 1,000 |  |   | 1,000 | 
| | Mortgage
  payable                                       |  | U.S. $  |  |               | 5.45 |              |  | 5.45  |  |      | 1,800 |  |   | 1,654 | 
| |                                                          |  |         |  |               |      |              |  |       |  |      |       |  |   |       | 
|
| |                                                          |  |         |  |               |      |              |  |       |  |      | 5,300 |  |   | 8,194 | 
| | Less -
  current maturities                              |  |         |  |               |      |              |  |       |  |      | 3,647 |  |   | 795   | 
| |                                                          |  |         |  |               |      |              |  |       |  |      |       |  |   |       | 
|
| |                                                          |  |         |  |               |      |              |  |       |  | $    | 1,653 |  | $ | 7,399 | 
| |                                                          |  |         |  |               |      |              |  |       |  |      |       |  |   |       | 
| | Weighted
  average interest rates at the end of the year |  |         |  |               | 4.33 |              |  | 5.89  |  |      |       |  |   |       | 

| |    |                                                                                                     |                                                                                         
| | -- | --------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------
| |    | (1)                                                                                                 | The
  promissory  notes contain covenants that require the Group to maintain $ 1,000 in 
| |    |                                                                                                     | deposits at
  all times otherwise the interest rate on the notes becomes the banks rate
| |    |                                                                                                     | plus 0.25%
  until the minimum deposit is maintained. As of December 31, 2006,          
| |    |                                                                                                     | management
  believes that the Group was in compliance with these ratios and            
| |    |                                                                                                     | terms.                                                                                  
| |    |                                                                                                     |                                                                                         
| | b. | As of
  December 31, 2006, the aggregate annual maturities of the long-term loans are
  as follows:

| |      |  |  |   |       |  | 
| | ---- |  |  | - | ----- |  | 
| | 2007 |  |  |   | 795   |  | 
| | 2008 |  |  |   | 4,303 |  | 
| | 2009 |  |  |   | 813   |  | 
| | 2010 |  |  |   | 1,803 |  | 
| | 2011 |  |  |   | 480   |  | 
| |      |  |  |   |       |  | 
|
| |      |  |  | $ | 8,194 |  | 
| |      |  |  |   |       |  | 

| |    |                                                                                          
| | -- | -----------------------------------------------------------------------------------------
| | c. | As for
  charges, see Note 11h.                                                          
| |    |                                                                                          
| | d. | As for
  financial ratios in respect of the Companys used credit line, see Note
  8a(1).

F  26

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | -------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:   | COMMITMENTS AND CONTINGENT LIABILITIES
|            |                                       
|            | a.                                     | Royalty
  commitments to the Office of the Chief Scientist of the Israeli Ministry of
  Industry and Trade (OCS):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | Under the
  research and development agreements of the Company with the OCS and pursuant
  to applicable laws, the Company is required to pay royalties at the rate of
  3%-4.5% of sales of products developed with funds provided by the OCS, up to
  an amount equal to 100% of the OCS research and development grants received,
  linked to the U.S. dollars plus interest on the unpaid amount received based
  on the 12-month LIBOR rate applicable to dollar deposits. The Company is
  obligated to repay the Israeli Government for the grants received only to the
  extent that there are sales of the funded products.
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | Royalties
  paid amounted to $61, $83 and $79 for the years ended December 31, 2004, 2005
  and 2006, respectively. As of December 31, 2006, the Company had remaining
  contingent obligations to pay royalties in the amount of approximately
  $1,652.                                                                                                                                                                                                                                                                                                                                                                           
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | b.                                     | Royalty
  commitments to the Fund for Encouragement of Marketing Activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | The Israeli
  Government, through the Fund for the Encouragement of Marketing Activities,
  awarded the Company grants for participation in expenses for foreign
  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. No
  royalties were paid during the years ended December 31, 2004, 2005 and 2006.
  As of December 31, 2006, the Companys aggregate contingent obligation
  amounted to $82.                                                                                                                                 
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | c.                                     | Royalty
  commitments to third party:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | During 2002,
  the Company entered into a development agreement for planning, developing and
  manufacturing a security system with a third party. Under the agreement, the
  Company agreed to pay the third party royalty fees, based on a formula as defined
  in the agreement. Under this agreement, the Company also committed to
  purchase a certain volume of products at a minimum amount of approximately
  $300 over 2.5 years after achievement of certain milestones. As of December
  31, 2006, royalty commitments under the agreement amounted to $22.                                                             
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | d.                                     | In September
  2006, the Company signed with a third party a non exclusive agreement for the
  rights to use certain intangible assets such as know-how and patents for the
  production, selling and marketing of perimeter security system based on
  fiber-optic that is used mainly to protect marine sites. The contract period
  is 2 years and the Company has the right to extend the contract for
  additional 5 years. The consideration for the license is $548, payable in 24
  monthly installments. In addition, the Company will pay royalties based on a
  formula as defined in the agreement.                     
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | In addition,
  the parties have signed an unlimited agreement that grants the Company the
  rights to provide maintenance and support for the systems sold previously by
  the third party. The Company agreed to pay royalties based on a formula as
  defined in the agreement.                                                                                                                                                                                                                                                                                                                                                   
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        | No royalties
  were paid or accrued as of December 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F  27

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|           |                                                |                                                                                                                                                                             
|---------- | ---------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:  | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|           |                                               
|           | e.                                             | Lease
  commitments:                                                                                                                                                        
|           |                                                |                                                                                                                                                                             
|           |                                                | The Group
  rents its facilities and some of its motor vehicles under various operating
  lease agreements, which expire on various dates, the latest of which is in
  2010.
|           |                                                |                                                                                                                                                                             
|           |                                                | Future
  minimum lease payments under non-cancelable operating lease agreements are as
  follows:                                                                           

| |      |  |   |       | 
| | ---- |  | - | ----- | 
| | 2007 |  | $ | 596   | 
| | 2008 |  |   | 460   | 
| | 2009 |  |   | 252   | 
| | 2010 |  |   | 68    | 
| |      |  |   |       | 
| |      |  |   |       | 
| |      |  | $ | 1,376 | 
| |      |  |   |       | 

| |    |                                                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Total rent
  expenses for the years ended December 31, 2004, 2005 and 2006, were
  approximately $671, $593 and $700, respectively.                                                              
| |    |                                                                                                                                                                                                  
| | f. | Guarantees:                                                                                                                                                                                      
| |    |                                                                                                                                                                                                  
| |    | As of
  December 31, 2006, the Group obtained bank performance guarantees and advance
  payment guarantees and bid bond guarantees from several banks mainly in
  Israel in the amount of $6,488.
| |    |                                                                                                                                                                                                  
| | g. | Legal
  proceedings:                                                                                                                                                                             
| |    |                                                                                                                                                                                                  
| |    | 1.                                                                                                                                                                                                | In April
  2003, a competitor filed a civil action suit against the Company and others.
  The plaintiff alleged that the failure of its perimeter systems in field
  trials executed by the Ministry of Defense during 1996 and 1997, resulted
  from intentional damage to the fence and diversion of the results of certain
  tests by a former employee of the Company, who was then a soldier in the
  Israeli Defense Force. The plaintiff alleged that the Company, which was the
  employer of this employee during 1995, still employed him as an agent during
  the field trials, and directed the actions of the former employee.                                                                                                                                           
| |    |                                                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                   | The
  plaintiff requested the courts to annul the field trial and sought
  approximately $714 in damages. The Company denied all of the above
  allegations and claimed that the plaintiffs perimeter system failure was not
  the result of the former employees actions. In July 2005, the parties agreed
  to appoint a mediator, as proposed by the court. As a result of the
  mediation, on December 5, 2006, the Company paid the competitor $29.                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | 2.                                                                                                                                                                                                | In May 2005,
  the Company entered into an agreement to supply comprehensive security
  solutions for a sensitive site in Europe. As part of the agreement, the
  Company received an advance payment, in the amount of $3,990, secured by a
  bank advance payment guarantee, which was to be reduced proportionally
  according to the progress of the execution of the project. In addition, the
  Company issued to the customer a bank performance guarantee in the amount of
  $1,436. The Company commenced the execution of the project and delivered part
  of the equipment and other deliverables to the customer. In April 2006, the
  customer informed the Company that it was canceling the agreement due to
  errors in the design documents submitted by the Company.

F  28

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | ---------------------------------------------- | ---------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:   | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|            |                                               
|            |                                                |                                                            | In addition,
  the customer did not make the payments required under the agreement. The
  Company believes that there are no factual or legal grounds for the
  cancellation and, accordingly, the agreement is still valid. Based on the
  cancellation of the agreement, the customer collected on June 20, 2006 $
  3,181 related to an advance payment that was secured by a bank guarantee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                |                                                            | On April 28,
  2006, the Company commenced arbitration proceedings against the customer. In
  these proceedings, the Company asked the arbitrators to find that the
  agreement is valid and to enforce the payment of the amounts due pursuant to
  the agreement. The customer denied the Companys allegations and filed a
  counter claim for liquidated damages in a foreign currency, which on December
  31, 2006, was equal to approximately $ 4.5 thousand. The hearing of the
  arbitration has been concluded and the case is still pending resolution of
  the arbitration panel.                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                |                                                            | Due to this
  uncertainty, the Company did not recognize any revenues from this project.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                |                                                            | On July 11,
  2006, the customer made a demand for the payment under the performance bank
  guarantee in the amount of approximately $ 1,436. Upon the Companys motion,
  the District Court in Haifa, Israel has issued a temporary injunction against
  the payment of such guarantee pending a hearing in August 2006. In view of
  the above, and due to the uncertainty in preventing the forfeiture of the
  performance bank guarantee, the Company included in its financial statements
  as of December 31, 2005, a provision in respect of this guarantee, in the
  amount of $ 1,436. At the hearing, the Company reached a settlement according
  to which the Company paid the customer 50% of the performance guarantee, and
  the balance is subject to the results of the arbitration and will be repaid
  only if pursuant to the arbitration award the Company will be found liable
  for damages that exceed the amount already paid by the Company.
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                |                                                            | Based on the
  opinion of the Companys legal counsel, the Company believes that there is a
  good likelihood to obtain judgment dismissing all claims raised by the
  customer. In view of the above, in 2006 the Company cancelled the balance of
  the provision made in its financial statements regarding the performance
  guarantee, and did not record any provision regarding the counter claim filed
  against it.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | h.                                             | Charges:                                                  
|            |                                                |                                                           
|            |                                                | As
  collateral for all of the Group liabilities to banks:
|            |                                                |                                                           
|            |                                                | 1.                                                         | A fixed
  charge has been placed on the Companys property.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                | 2.                                                         | The Company
  agreed not to pledge any of its assets without the consent of several banks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                | 3.                                                         | A fixed
  charge in the amount of $ 3,000 has been placed on the Companys bank
  deposits.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                                |                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                | 4.                                                         | A subsidiary
  of the Company has two bank promissory notes in the aggregate amount of $
  1,000 due on July 17, 2008, collateralized by substantially all of the
  subsidiarys assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F  29

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|---------- | ---------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:  | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|           |                                               
|           | i.                                             | In October
  2006, the Company signed an agreement with a third party, which consults,
  markets and implements projects in the security field. According to the
  agreement, during the first 12 months (the agreement period), the parties
  agreed to cooperate in the development of the business of the third party.                                                                                                                                                                                                                                                                                                                                                                                                          
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | The Company
  has granted a loan to the third party in the amount of $ 600. The Company
  will also provide the third party with additional monthly amounts to fund its
  activities during the agreement period, that will not exceed $ 23 per month.
  The loan and the monthly amounts will bear an annual interest rate of 5%, and
  shall be paid in October 2011.                                                                                                                                                                                                                                                                                                                                                              
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | The Company
  received an option to purchase all of the assets of the third partys
  business, exercisable during the agreement period (the option). The Company
  is obligated to exercise the option if the third party will meet certain
  milestones. The exercise price of the option is comprised of the outstanding
  loan and the monthly amounts mentioned above and an additional $ 400 in cash.
  In the event that the Company will exercise the option, the beneficial owner
  of the third party will be entitled to receive 50% of the operating profit of
  certain projects, as defined in the agreement.                                                                                                        
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|NOTE 12:  | SHAREHOLDERS EQUITY                          
|           |                                               
|           | a.                                             | Pertinent
  rights and privileges conferred by Ordinary shares:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | The Ordinary
  shares of the Company are listed for trade on NASDAQ Global Market and in
  Israel, on the Tel-Aviv Stock Exchange. 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.                                             | Issued and
  outstanding share capital:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | On April 19,
  2005, the Company completed a public offering of $ 16.3 thousand in
  consideration of 1,700,000 of the Companys Ordinary shares at a price per
  share of $ 9.5 and at a price of $ 9.92 (the closing price of the Ordinary
  shares on the date of the transaction) to two principal shareholders of the
  Company.                                                                                                                                                                                                                                                                                                                                                                                                
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           | c.                                             | Stock Option
  Plan:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | On October
  27, 2003, the Companys Board of Directors approved the 2003 Israeli Share
  Option Plan (the 2003 Plan). Under the 2003 Plan, stock options will be
  periodically granted to employees, directors, officers and consultants of the
  Company or its subsidiaries, in accordance with the decision of the Board of
  Directors of the Company (or a committee appointed by it). The Board of
  Directors has the authority to determine the number 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, and the purchase price thereof.
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | The 2003
  Plan is effective for ten years and shall terminate in October 2013. Any
  options that are cancelled or forfeited before expiration become available
  for future grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           |                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                | As of
  December 31, 2006, there were 301,475 options available for future grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F  30

---

---



|                                                             
|-------------------------------------------------------------
|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 summary of the Companys
  stock options activities in 2004, 2005 and 2006, is as follows:

| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| | ---------------------------------------- |  | ----------------------- | -------- | ---------------------------------------- | - | -------------------- |  | ---------------------------------------- | ------- | -------------------- | - | ---------------------------------------- |  |  | ------- | - | - | ---- | 
| |                                          |  | Year ended December 31, |         
| |                                          |  |                         |         
| |                                          |  | 2004                    |          | 2005                                     |   | 2006                 | 
| |                                          |  |                         |          |                                          |   |                      | 
| |                                          |  | Number 
  of options    |          | Weighted 
  average 
  exercise 
  price |   | Number 
  of options |  | Weighted 
  average 
  exercise 
  price |         | Number 
  of options |   | Weighted 
  average 
  exercise 
  price | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| | Outstanding at beginning of year         |  |                         | 223,216  |                                          | $ | 4.61                 |  |                                          | 105,000 |                      | $ | 7.66                                     |  |  | 343,000 |   | $ | 8.35 | 
| | Granted                                  |  |                         | 100,000  |                                          | $ | 7.66                 |  |                                          | 238,000 |                      | $ | 8.65                                     |  |  | -       |   |   |      | 
| | Adjustment as a result of stock dividend |  |                         | 7,652    |                                          | $ | -                    |  |                                          | -       |                      | $ | -                                        |  |  | -       |   |   |      | 
| | Exercised                                |  |                         | (225,338 | )                                        | $ | 4.61                 |  |                                          | -       |                      | $ | -                                        |  |  | (19,100 | ) | $ | 8.56 | 
| | Forfeited                                |  |                         | (530     | )                                        | $ | -                    |  |                                          | -       |                      | $ | -                                        |  |  | (1,800  | ) | $ | 8.56 | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| | Outstanding at end of year               |  |                         | 105,000  |                                          | $ | 7.66                 |  |                                          | 343,000 |                      | $ | 8.35                                     |  |  | 322,100 |   | $ | 8.34 | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 
| | Exercisable options at end of year       |  |                         | -        |                                          | $ | -                    |  |                                          | 231,200 |                      | $ | 8.56                                     |  |  | 317,100 |   | $ | 8.26 | 
| |                                          |  |                         |          |                                          |   |                      |  |                                          |         |                      |   |                                          |  |  |         |   |   |      | 

| |  |                                                                                                                  
| |  | -----------------------------------------------------------------------------------------------------------------
| |  | The options outstanding as
  of December 31, 2006 have been separated into ranges of exercise price as
  follows:

| |                                                         |  |                   |       |                                                      |             |                                                  |  |  |         | 
| | ------------------------------------------------------- |  | ----------------- | ----- | ---------------------------------------------------- | ----------- | ------------------------------------------------ |  |  | ------- | 
| | Options 
  outstanding 
  as of 
  December 31, 
  2006 |  | Exercise 
  price |       | Weighted 
  average 
  remaining 
  contractual life |             | Options
  exercisable as
  ofDecember 31,
  2006 | 
| |                                                         |  |                   |       |                                                      |             |                                                  | 
| |                                                         |  |                   |       |                                                      | (in months) |                                                  |  |  |        
| |                                                         |  |                   |       |                                                      |             |                                                  |  |  |         | 
| | 105,000                                                 |  | $                 | 7.66  |                                                      |             | 24.9                                             |  |  | 105,000 | 
| | 212,100                                                 |  | $                 | 8.56  |                                                      |             | 47.7                                             |  |  | 212,100 | 
| | 5,000                                                   |  | $                 | 13.00 |                                                      |             | 47.7                                             |  |  | -       | 
| |                                                         |  |                   |       |                                                      |             |                                                  |  |  |         | 
| |                                                         |  |                   |       |                                                      |             |                                                  |  |  |         | 
| | 322,100                                                 |  | $                 | 8.34  |                                                      |             |                                                  |  |  | 317,100 | 
| |                                                         |  |                   |       |                                                      |             |                                                  |  |  |         | 

| |    |            |                                                                                                                                                                                                                                                                                                           
| | -- | ---------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | d. | Dividends:
| |    |            |                                                                                                                                                                                                                                                                                                           
| |    | 1.         | Dividends, if any, will be
  declared and paid in U.S. dollars. Dividends paid to shareholders in Israel
  will be converted into NIS 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.
| |    |            |                                                                                                                                                                                                                                                                                                           
| |    | 2.         | The Companys Board of
  Directors declared stock dividends of 3%, 3% and 5% in May 2002, May 2003 and
  July 2004, respectively. All shares, options and net earnings per share data
  have been retroactively adjusted to reflect the stock dividends.                                                  
| |    |            |                                                                                                                                                                                                                                                                                                           
| |    | 3.         | At the Annual General
  Meeting of Shareholders held on July 29, 2004, the shareholders approved the
  payment of an interim cash dividend in the amount of $ 0.05 per Ordinary
  share of NIS 1 par value each, which was declared by the Board of Directors
  in December 2003.                         

F  31

---

---



|                                                             
|-------------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                  
|AND ITS SUBSIDIARIES                                         
|NOTES TO
  CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                             
|U.S.
  dollars in thousands (except share and per share data)

|            |                                            | 
|----------- | ------------------------------------------ | 
|NOTE 13:   | BASIC AND
  DILUTED NET EARNINGS PER SHARE

| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | --------------------------------------------------------------------------------------------------------- |  | ----------------------- | --------- | ---- | - | --------- | - | - | ---------- | -
| |                                                                                                           |  | Year ended December 31, |          
| |                                                                                                           |  |                         |          
| |                                                                                                           |  | 2004                    |           | 2005 |   | 2006      |  
| |                                                                                                           |  |                         |           |      |   |           |  
| | Numerator:                                                                                                |  |                         |           |      |   |           |   |   |            |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | Income (loss) from continuing operations                                                                  |  | $                       | 1,174     |      | $ | (3,055    | ) | $ | 938        |  
| | Gain (loss) on discontinued operations                                                                    |  |                         | (121      | )    |   | (156      | ) |   | (128       | )
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
|
| | Net income (loss)                                                                                         |  | $                       | 1,053     |      | $ | (3,211    | ) | $ | 810        |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
|
| | Denominator:                                                                                              |  |                         |           |      |   |           |   |   |            |  
| | Denominator for basic net earnings per share - weighted-average number
  of shares outstanding            |  |                         | 8,581,348 |      |   | 9,883,407 |   |   | 10,384,047 |  
| | Effect of diluting securities:                                                                            |  |                         |           |      |   |           |   |   |            |  
| | Employee stock options                                                                                    |  |                         | 55,031    |      |   | 16,926    |   |   | 57,777     |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
|
| | Denominator for diluted net earnings per share - adjusted weighted
  average shares and assumed exercises |  |                         | 8,636,379 |      |   | 9,900,333 |   |   | 10,441,824 |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | Basic net earnings (loss) per share from continuing
operations                                            |  | $                       | 0.13      |      | $ | (0.31     | ) | $ | 0.09       |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | Basic net loss per share from discontinued operations                                                     |  |                         | (0.01     | )    |   | (0.01     | ) |   | (0.01      | )
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
|
| | Basic net earnings (loss) per share                                                                       |  | $                       | 0.12      |      | $ | (0.32     | ) | $ | 0.08       |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | Diluted net earnings (loss) per share form continuing
operations                                          |  | $                       | 0.13      |      | $ | (0.31     | ) | $ | 0.09       |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
| | Diluted net loss per share from discontinued operations                                                   |  |                         | (0.01     | )    |   | (0.01     | ) |   | (0.01      | )
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  
|
| | Diluted net earnings (loss) per share                                                                     |  | $                       | 0.12      |      | $ | (0.32     | ) | $ | 0.08       |  
| |                                                                                                           |  |                         |           |      |   |           |   |   |            |  

F  32

---

---



|                                                             
|-------------------------------------------------------------
|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 two expansion programs under which the Company is entitled to tax
  benefits:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                   | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | On March 18, 1997, a
  program of the Company was granted the status of an Approved Enterprise.
  The Company elected to enjoy the alternative benefits track - waiver of
  grants in return for tax exemption and accordingly, the Companys income from
  this program was tax-exempt for a period of four years, and is 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 1998 and will terminate in 2007.
|            |                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                   | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | On August 13, 2002, a
  program of the Company was granted the status of an Approved Enterprise.
  The Company elected to enjoy the alternative benefits track - 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, and is 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 began in 2003 and will terminate in 2012.              
|            |                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                   | The entitlement to the
  above benefits is conditional upon the Company fulfilling the conditions
  stipulated by the Law, regulations published there under and the letters 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. As of December 31, 2006, management believes
  that the Company is in compliance with all of the aforementioned conditions.                                                                                                                                                                                                                                                                                                                                  
|            |                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                   | A recent amendment to the
  Law, which has been officially published effective as of April 1, 2005 (the
  Amendment), has changed certain provisions of the Law. As a result of the
  Amendment, a company is no longer obliged to implement an Approved Enterprise
  status in order to receive the tax benefits previously available under the
  Alternative Benefits provisions, and therefore there is no need to apply to
  the Investment Center for this purpose (Approved Enterprise status remains
  mandatory for companies seeking grants). Rather, a company may claim the tax
  benefits offered by the Investment Law directly in its tax returns, provided
  that its facilities meet the criteria for tax benefits set out by the
  Amendment. A company is also granted a right to approach the Israeli Tax
  Authority for a pre-ruling regarding their eligibility for benefits under the
  Amendment.

F  33

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|             |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                           | Tax benefits are available
  under the Amendment to production facilities (or other eligible facilities),
  which are generally required to derive more than 25% of their business income
  from export. In order to receive the tax benefits, the Amendment states that
  a company must make an investment in the Beneficiary Enterprise exceeding a
  minimum amount specified in the Law. Such investment may be made over a
  period of no more than three years ending at the end of the year in which a
  company requested to have the tax benefits apply to the Beneficiary
  Enterprise (the Year of Election). Where a company requests to have the tax
  benefits apply to an expansion of existing facilities, then only the
  expansion will be considered a Beneficiary Enterprise and the companys effective
  tax rate will be the result of a weighted combination of the applicable
  rates. In this case, the minimum investment required in order to qualify as a
  Beneficiary Enterprise is required to exceed a certain percentage of the
  companys production assets before the expansion. The duration of tax
  benefits is subject to a limitation of the earlier of 7 years from the
  Commencement Year, or 12 years from the first day of the Year of Election.
|             |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                           | On March 3, 2007, the
  Company received a pre-ruling from the Israeli Tax Authority, for its request
  for a Benefiting Facility, regarding eligibility for benefits under the
  Amendment. The Companys income from this program is tax-exempt for a period
  of two years, and is 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 Company did not yet enjoy the tax benefits from this
  program.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                           | Income from sources other
  than Approved Enterprise, during the benefit period will be subject to tax
  at regular rate of 31% in 2006 (see e. below).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                           | By virtue of the 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 31%), 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%).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F  34

---

---



|                                                             
|-------------------------------------------------------------
|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.)
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            | b.                        | Measurement of taxable
  income under the Income Tax (Inflationary Adjustments) Law, 1985:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            |                           | Under the Income Tax
  (Inflationary Adjustments) Law, 1985, results for tax purposes are measured
  in real terms, in accordance with the changes in the Israeli Consumer Price
  Index (Israeli CPI). Accordingly, until 2002, results for tax purposes were
  measured in terms of earnings in NIS after certain adjustments for increases
  in the Israeli CPI. Commencing in taxable year 2003, the Company has elected
  to measure its taxable income and file its tax return under the Israeli
  Income Tax Regulations (Principles Regarding the Management of Books of
  Account of Foreign Invested Companies and Certain Partnerships and the
  Determination of Their Taxable Income), 1986. Such an elective obligates the
  Company for three years. Accordingly, commencing taxable year 2003, results
  for tax purposes are measured in terms of earnings in dollar.
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            | d.                        | The Company is in a
  process of tax assessment for the years 2001-2004. The Israeli Tax Authority
  issued tax assessment for the year 2001 in the amount of approximately $ 850
  including interest and linkage differences. The Company submitted an
  objection to this assessment and is negotiating with the Israeli Tax
  Authority. To the managements opinion, the Company has good arguments
  against this assessment. The Company estimates that it is more likely than
  not that it will not have to pay this amount, and therefore did not record
  any provision regarding this assessment.                                                                                                                                                                                                                                                                           
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            | e.                        | Tax rates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            |                           | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | On July 25, 2005, the
  Knesset (Israeli Parliament) passed the Law for the Amendment of the Income
  Tax Ordinance (No. 147), 2005, which prescribes, among others, a gradual
  decrease in the corporate tax rate in Israel to the following tax rates: in
  2006 - 31%, in 2007 - 29%, in 2008 - 27%, in 2009 - 26% and in 2010 and
  thereafter - 25%.
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            |                           | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | The tax rates of the
  Companys subsidiaries range between 25%-40%.                                                                                                                                                                                                                                                                                      
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            | f.                        | Investment tax credit:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            |                           | Two of the Companys
  subsidiaries are eligible for investment tax credits on their research and
  development activities and on certain current and capital expenditures.
  During the year ended December 31, 2006, the subsidiaries recognized $ 162 of
  investment tax credits as a reduction of research and development expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                           
|            |                           | In total, the subsidiaries have
   investment tax credits available to reduce future federal income taxes
  payable, amounting to $ 208, which will expire in 2016-2023.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F  35

---

---



|                                                           
|-----------------------------------------------------------
|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. | Reconciliation
  between the theoretical tax expense, assuming all income is taxed at the
  Israeli statutory rate, and the actual tax expense, is as follows:

| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  
| | ------------------------------------------------------------------------------------------------ |  | ----------------------- | ----- | ---- | - | ------ | - | - | ----- | -
| |                                                                                                  |  | Year ended December 31, |      
| |                                                                                                  |  |                         |      
| |                                                                                                  |  | 2004                    |       | 2005 |   | 2006   |  
| |                                                                                                  |  |                         |       |      |   |        |  
| | Income (loss) before taxes as reported in
  the statements of operations                         |  | $                       | 2,307 |      | $ | (3,078 | ) | $ | 1,886 |  
| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  
|
| | Tax rate                                                                                         |  |                         | 35    | %    |   | 34     | % |   | 31    | %
| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  
| | Theoretical tax expense (tax benefit)                                                            |  | $                       | 807   |      | $ | (1,047 | ) | $ | 585   |  
|
| | Increase (decrease) in taxes:                                                                    |  |                         |       |      |   |        |   |   |       |  
| | Non-deductible items, net                                                                        |  |                         | (400  | )    |   | 25     |   |   | 48    |  
| | Deferred taxes on losses for which
  valuation allowance was provided                            |  |                         | 1,163 |      |   | 579    |   |   | 452   |  
| | Tax exemption applicable to Approved
  Enterprises and exempted income                         |  |                         | (302  | )    |   | 347    |   |   | (75   | )
| | Taxes in respect of prior years                                                                  |  |                         | (23   | )    |   | 52     |   |   | 1     |  
| | Other (1)                                                                                        |  |                         | (112  | )    |   | 21     |   |   | (63   | )
| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  
|
| | Taxes on income (tax benefit) in the
  statements of operations                                  |  | $                       | 1,133 |      | $ | (23    | ) | $ | 948   |  
| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  
|
| | Per share amounts (basic and diluted) of
  the tax benefit resulting from Approved Enterprises |  | $                       | 0.03  |      | $ | (0.04  | ) | $ | 0.01  |  
| |                                                                                                  |  |                         |       |      |   |        |   |   |       |  

| |    |                                                                          
| | -- | -------------------------------------------------------------------------
| |    | (1)
  Including conversion of monetary items for tax purposes.           
| |    |                                                                          
| | h. | Taxes on
  income (tax benefit) included in the statements of operations:

| |                                                            |  |   |       |   |   |      |   |   |       |  
| | ---------------------------------------------------------- |  | - | ----- | - | - | ---- | - | - | ----- | -
| | Current:                                                   |  |   |       |   |   |      |   |   |       |  
| | Domestic                                                   |  | $ | 460   |   | $ | -    |   | $ | -     |  
| | Foreign                                                    |  |   | 518   |   |   | 620  |   |   | 1,041 |  
|
| | Deferred:                                                  |  |   |       |   |   |      |   |   |       |  
| | Domestic                                                   |  |   | (70   | ) |   | (642 | ) |   | 248   |  
| | Foreign                                                    |  |   | 248   |   |   | (53  | ) |   | (342  | )
|
| | Taxes in respect of prior years:                           |  |   |       |   |   |      |   |   |       |  
| | Domestic                                                   |  |   | -     |   |   | -    |   |   | 1     |  
| | Foreign                                                    |  |   | (23   | ) |   | 52   |   |   | -     |  
| |                                                            |  |   |       |   |   |      |   |   |       |  
|
| | Taxes on income (tax benefit) from
  continuing operations |  |   | 1,133 |   |   | (23  | ) |   | 948   |  
| | Tax benefit from discontinued operations                   |  |   | (32   | ) |   | (36  | ) |   | (34   | )
| |                                                            |  |   |       |   |   |      |   |   |       |  
|
| | Total taxes on income (tax benefit)                        |  | $ | 1,101 |   | $ | (59  | ) | $ | 914   |  
| |                                                            |  |   |       |   |   |      |   |   |       |  

F  36

---

---



|                                                           
|-----------------------------------------------------------
|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.)
|            |                        
|            | i.                      | 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
  Groups deferred tax assets are as follows:

| |                                                    |  |              |        |      |   |        |  
| | -------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | -
| |                                                    |  | December 31, |       
| |                                                    |  |              |       
| |                                                    |  | 2005         |        | 2006 |  
| |                                                    |  |              |        |      |  
|
| | Operating
  loss carryforward                      |  | $            | 3,923  |      | $ | 4,339  |  
| | Reserves and
  tax allowances                      |  |              | 963    |      |   | 1,274  |  
| |                                                    |  |              |        |      |   |        |  
|
| | Total
  deferred assets before valuation allowance |  |              | 4,886  |      |   | 5,613  |  
| | Valuation
  allowance                              |  |              | (2,871 | )    |   | (3,323 | )
| |                                                    |  |              |        |      |   |        |  
|
| | Net deferred
  tax assets                          |  | $            | 2,015  |      | $ | 2,290  |  
| |                                                    |  |              |        |      |   |        |  
|
| | Domestic                                           |  | $            | 1,553  |      | $ | 1,456  |  
| | Foreign                                            |  |              | 462    |      |   | 834    |  
| |                                                    |  |              |        |      |   |        |  
|
| |                                                    |  | $            | 2,015  |      | $ | 2,290  |  
| |                                                    |  |              |        |      |   |        |  

| |    |                                                                                    
| | -- | -----------------------------------------------------------------------------------
| | j. | The domestic
  and foreign components of income (loss) before taxes are as follows:

| |          |  |                         |       |      |   |        |   |   |       | 
| | -------- |  | ----------------------- | ----- | ---- | - | ------ | - | - | ----- | 
| |          |  | Year ended December 31, |      
| |          |  |                         |      
| |          |  | 2004                    |       | 2005 |   | 2006   |  
| |          |  |                         |       |      |   |        |  
|
| | Domestic |  | $                       | 2,290 |      | $ | (2,998 | ) | $ | 564   | 
| | Foreign  |  |                         | 17    |      |   | (80    | ) |   | 1,322 | 
| |          |  |                         |       |      |   |        |   |   |       | 
|
| |          |  | $                       | 2,307 |      | $ | (3,078 | ) | $ | 1,886 | 
| |          |  |                         |       |      |   |        |   |   |       | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | k. | Net
  operating losses carryforward:                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | The Company
  has estimated total available carryforward tax losses of $1,259 to offset
  against future taxable income.                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | The
  Companys subsidiaries in the U.S. and the U.K. have estimated total
  available carryforward tax losses of $9,802 and $911, respectively, to offset
  against future taxable income for 16 to 20 years, and an indefinite period,
  respectively. As of December 31, 2006, the Company recorded a full valuation
  allowance of the subsidiaries abovementioned tax assets due to the
  uncertainty of their future realization.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | 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.                                                                                                                        

F  37

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.
  AND ITS SUBSIDIARIES         
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|            |                                                |                                 
|----------- | ---------------------------------------------- | --------------------------------
|NOTE 15:   | BALANCES AND TRANSACTIONS WITH RELATED PARTIES
|            |                                               
|            | a.                                             | Balances
  with related parties:
|            |                                                |                                 

| |                                 |  |              |     |      |   |    |  | 
| | ------------------------------- |  | ------------ | --- | ---- | - | -- |  | 
| |                                 |  | December 31, |    
| |                                 |  |              |    
| |                                 |  | 2005         |     | 2006 |   |   
| |                                 |  |              |     |      |   |   
|
| | Balances
  with related parties |  | $            | 290 |      | $ | 59 |  | 
| |                                 |  |              |     |      |   |    |  | 
| |                                 |  |              |     |      |   |    |  | 

| |    |                            
| | -- | ---------------------------
| | b. | Sales to
  related parties:

| |                                |  |                         |     |      |   |      |  |   |     | 
| | ------------------------------ |  | ----------------------- | --- | ---- | - | ---- |  | - | --- | 
| |                                |  | Year ended December 31, |    
| |                                |  |                         |    
| |                                |  | 2004                    |     | 2005 |   | 2006 | 
| |                                |  |                         |     |      |   |      | 
| | Sales to
  related parties (1) |  | $                       | 386 |      | $ | 671  |  | $ | 765 | 
| |                                |  |                         |     |      |   |      |  |   |     | 

|            |                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                             |                                                                                    
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------
|            |                                                                                                                                                                                                                                | (1)                                                                                                                                                                                                                                                                                         | Sales to
  related parties represent services provided by the Companys subsidiary.
|            |                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                            
|NOTE 16:   | SEGMENT INFORMATION                                                                                                                                                                                                           
|            |                                                                                                                                                                                                                               
|            | The Group
  adopted SFAS No. 131, Disclosures about Segments of an Enterprise and
  Related Information. The Group operates in three major reportable segments,
  which represent the Groups operating segments as follows:
|            |                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                            
|            | 1.                                                                                                                                                                                                                             | Perimeter
  security systems - The Group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, field disturbance sensors, and other.
|            |                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                             |                                                                                    
|            | 2.                                                                                                                                                                                                                             | Security
  turnkey projects - The Group executes turnkey projects based on the Companys
  security management system and acts as an integrator.                                                                                                                                           
|            |                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                             |                                                                                    
|            | 3.                                                                                                                                                                                                                             | Video
  monitoring services - The Group supplies video monitoring services through
  Smart Interactive Systems, Inc., a U.S. subsidiary.                                                                                                                                                   

F  38

---

---



|                                                           
|-----------------------------------------------------------
|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:   | SEGMENT INFORMATION (Cont.)
|            |                             |                                                                                                                              
|            | a.                          | The
  following data present the revenues, expenditures, assets and other operating
  data of the Groups operating segments:

|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 
|------------------------------------------------------------------------ |  | ----------------------- | ------ | -------- | - | ------------------ |  | ----- | ------ | ----- | - | --------- | - | -------- | ------ | ------------------ | - | ------ |  | ----- | ------ | --------- | - | -------- | - | ------------------ | --- | ----- | - | ------ | - |  | ------ |  |  | ------ |  |  | ------ | - |  | ---- | - | - | ------ | 
|                                                                         |  | Year ended December 31, |       
|                                                                         |  |                         |       
|                                                                         |  | 2004                    |        | 2005     |   | 2006               | 
|                                                                         |  |                         |        |          |   |                    | 
|                                                                         |  | Perimeter               |        | Projects |   | Video
  monitoring |  | Other |        | Total |   | Perimeter |   | Projects |        | Video
  monitoring |   | Other  |  | Total |        | Perimeter |   | Projects |   | Video
  monitoring |     | Other |   | Total  |  
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |  
|Revenues                                                                 |  | $                       | 46,342 |          | $ | 11,375             |  | $     | 2,060  |       | $ | 691       |   | $        | 60,468 |                    | $ | 40,143 |  | $     | 17,970 |           | $ | 2,897    |   | $                  | 272 |       | $ | 61,282 |   |  | 47,186 |  |  | 16,167 |  |  | 3,358  |   |  | 247  |   |   | 66,958 | 
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 
|Depreciation and
  amortization                                          |  | $                       | 1,252  |          | $ | 11                 |  | $     | 698    |       | $ | 5         |   | $        | 1,966  |                    | $ | 1,228  |  | $     | 19     |           | $ | 713      |   | $                  | 4   |       | $ | 1,964  |   |  | 1,070  |  |  | 133    |  |  | 952    |   |  | -    |   |   | 2,155  | 
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 
|Operating income (loss),
  before financial expenses and taxes on income |  | $                       | 4,978  |          | $ | 1,430              |  | $     | (2,262 | )     | $ | (1,077    | ) | $        | 3,069  |                    | $ | 4,334  |  | $     | (5,290 | )         | $ | (1,375   | ) | $                  | 53  |       | $ | (2,278 | ) |  | 3,070  |  |  | 935    |  |  | (1,130 | ) |  | (138 | ) |   | 2,737  | 
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 
|Financial expenses, net                                                  |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          | 762    |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   | 800    |   |  |        |  |  |        |  |  |        |   |  |      |   |   | 851    | 
|Taxes on income                                                          |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          | 1,133  |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   | (23    | ) |  |        |  |  |        |  |  |        |   |  |      |   |   | 948    | 
|Loss from discontinued
  operations, net                                 |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          | 121    |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   | 156    |   |  |        |  |  |        |  |  |        |   |  |      |   |   | 128    | 
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 
|Net income (loss)                                                        |  |                         |        |          |   |                    |  |       |        |       |   |           |   | $        | 1,053  |                    |   |        |  |       |        |           |   |          |   |                    |     |       | $ | (3,211 | ) |  |        |  |  |        |  |  |        |   |  |      |   | $ | 810    | 
|                                                                         |  |                         |        |          |   |                    |  |       |        |       |   |           |   |          |        |                    |   |        |  |       |        |           |   |          |   |                    |     |       |   |        |   |  |        |  |  |        |  |  |        |   |  |      |   |   |        | 

|                        |  |              |        |          |   |                    |  |       |       |       |   |           |  |          |        |                    |   |        |  |       |     |           |   |          |  |                    |    |       |   |        |  |  |        |  |  |     |  |  |       |  |  |    |  |  |        | 
|----------------------- |  | ------------ | ------ | -------- | - | ------------------ |  | ----- | ----- | ----- | - | --------- |  | -------- | ------ | ------------------ | - | ------ |  | ----- | --- | --------- | - | -------- |  | ------------------ | -- | ----- | - | ------ |  |  | ------ |  |  | --- |  |  | ----- |  |  | -- |  |  | ------ | 
|                        |  | December 31, |       
|                        |  |              |       
|                        |  | 2004         |        | 2005     |   | 2006               | 
|                        |  |              |        |          |   |                    | 
|                        |  | Perimeter    |        | Projects |   | Video
  monitoring |  | Other |       | Total |   | Perimeter |  | Projects |        | Video
  monitoring |   | Other  |  | Total |     | Perimeter |   | Projects |  | Video
  monitoring |    | Other |   | Total  | 
|                        |  |              |        |          |   |                    |  |       |       |       |   |           |  |          |        |                    |   |        |  |       |     |           |   |          |  |                    |    |       |   |        | 
|Total long-lived assets |  | $            | 13,576 |          | $ | 192                |  | $     | 5,814 |       | $ | 19        |  | $        | 19,601 |                    | $ | 13,042 |  | $     | 194 |           | $ | 7,087    |  | $                  | 19 |       | $ | 20,342 |  |  | 12,451 |  |  | 552 |  |  | 6,778 |  |  | 20 |  |  | 19,801 | 
|                        |  |              |        |          |   |                    |  |       |       |       |   |           |  |          |        |                    |   |        |  |       |     |           |   |          |  |                    |    |       |   |        |  |  |        |  |  |     |  |  |       |  |  |    |  |  |        | 

F  39

---

---



|                                                             
|-------------------------------------------------------------
|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:   | SEGMENT
  INFORMATION (Cont.)
|            |                               |                                                      
|            | b.                            | Major customer data (percentage
  of total revenues):

| |            |  |                           |       |      |  |      |   |  |      |   | 
| | ---------- |  | ------------------------- | ----- | ---- |  | ---- | - |  | ---- | - | 
| |            |  | Year ended
  December 31, |      
| |            |  |                           |      
| |            |  | 2004                      |       | 2005 |  | 2006 |   | 
| |            |  |                           |       |      |  |      |   | 
|
| | Customer A |  |                           | *  )- |      |  | 23.9 | % |  | 33.7 | % | 
| |            |  |                           |       |      |  |      |   |  |      |   | 
|
| | Customer B |  |                           | 15.7  | %    |  | 10.2 | % |  | * )- |   | 
| |            |  |                           |       |      |  |      |   |  |      |   | 

| |    |                                                                                                                            |                                   
| | -- | -------------------------------------------------------------------------------------------------------------------------- | ----------------------------------
| |    | *)                                                                                                                         | Less than 10% of total
  revenues.
| |    |                                                                                                                            |                                   
| | 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, |       
| |    |                            |  |                           |       
| |    |                            |  | 2004                      |        | 2005 |   | 2006   | 
| |    |                            |  |                           |        |      |   |        | 
| | 1. | Revenues:                  |  |                           |        |      |   |        |  |   |        | 
| |    |                            |  |                           |        |      |   |        |  |   |        | 
| |    | Israel                     |  | $                         | 9,617  |      | $ | 19,309 |  | $ | 26,385 | 
| |    | Romania                    |  |                           | 9,521  |      |   | 6,244  |  |   | 1,531  | 
| |    | Europe (excluding Romania) |  |                           | 9,150  |      |   | 3,691  |  |   | 8,262  | 
| |    | USA                        |  |                           | 17,871 |      |   | 13,185 |  |   | 11,904 | 
| |    | Mexico                     |  |                           | 4,049  |      |   | 3,165  |  |   | 7,456  | 
| |    | Canada                     |  |                           | 4,068  |      |   | 8,759  |  |   | 5,630  | 
| |    | Others                     |  |                           | 6,192  |      |   | 6,929  |  |   | 5,790  | 
| |    |                            |  |                           |        |      |   |        |  |   |        | 
| |    |                            |  | $                         | 60,468 |      | $ | 61,282 |  | $ | 66,958
| |    |                            |  |                           |        |      |   |        |  |   |        | 
| | 2. | Long-lived assets:         |  |                           |        |      |   |        |  |   |        | 
| |    |                            |  |                           |        |      |   |        |  |   |        | 
| |    | Israel                     |  | $                         | 3,211  |      | $ | 2,930  |  | $ | 2,763  | 
| |    | Europe                     |  |                           | 1,069  |      |   | 921    |  |   | 1,001  | 
| |    | USA                        |  |                           | 11,518 |      |   | 12,714 |  |   | 12,247 | 
| |    | Canada                     |  |                           | 3,649  |      |   | 3,656  |  |   | 3,648  | 
| |    | Others                     |  |                           | 154    |      |   | 121    |  |   | 142    | 
| |    |                            |  |                           |        |      |   |        |  |   |        | 
| |    |                            |  | $                         | 19,601 |      | $ | 20,342 |  | $ | 19,801 | 
| |    |                            |  |                           |        |      |   |        |  |   |        | 

F  40

---

---



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

|                                                          |  |                         |       |      |   |       |  |   |       | 
|--------------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | ----- | 
|                                                          |  | Year ended December 31, |      
|                                                          |  |                         |      
|                                                          |  | 2004                    |       | 2005 |   | 2006  | 
|                                                          |  |                         |       |      |   |       | 
|                                                          |  |                         |       |      |   |       |  |   |       | 
|Expenses                                                  |  | $                       | 5,088 |      | $ | 5,427 |  | $ | 5,540 | 
|Less -
  royalty-bearing grants and investment tax credit |  |                         | 405   |      |   | 162   |  |   | 162   | 
|                                                          |  |                         |       |      |   |       |  |   |       | 
|                                                          |  |                         |       |      |   |       |  |   |       | 
|                                                          |  | $                       | 4,683 |      | $ | 5,265 |  | $ | 5,378 | 
|                                                          |  |                         |       |      |   |       |  |   |       | 

|   |                      
|-- | ---------------------
|b. | Financial
  expenses:

|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|------------------------------------------------------------------------------------------------ |  | - | ------ | - | - | ------ | - | - | ------ | -
|Financial
  expenses:                                                                            |  |   |        |   |   |        |   |   |        |  
|Interest on long-term debt                                                                       |  | $ | (289   | ) | $ | (622   | ) | $ | (698   | )
|Interest on short-term bank credit                                                               |  |   | (849   | ) |   | (630   | ) |   | (689   | )
|Forward contracts loss                                                                           |  |   | -      |   |   | (110   | ) |   | (915   | )
|Foreign exchange losses                                                                          |  |   | (161   | ) |   | (314   | ) |   | (337   | )
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  |   | (1,299 | ) |   | (1,676 | ) |   | (2,639 | )
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|Financial
  income:                                                                              |  |   |        |   |   |        |   |   |        |  
|Interest on short-term and long-term bank
  deposits, structured notes and marketable securities |  |   | 496    |   |   | 707    |   |   | 1,175  |  
|Foreign exchange gains                                                                           |  |   | 41     |   |   | 169    |   |   | 613    |  
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  |   | 537    |   |   | 876    |   |   | 1,788  |  
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  |   |        |   |   |        |   |   |        |  
|                                                                                                 |  | $ | (762   | ) | $ | (800   | ) | $ | (851   | )
|                                                                                                 |  |   |        |   |   |        |   |   |        |  

|            |                        
|----------- | -----------------------
|NOTE 18:  - | DISCONTINUED OPERATIONS

| |    |                                                                                                                                                                                                                                                                                      
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | General:                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                      
| |    | On July 28,
  2005, the Company decided to dispose of the indoor security sensors
  operations (the operations).                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                      
| |    | In view of
  the above, the operating results and cash flows attributed to the operations
  were presented in the Companys statements of operations and cash flows as
  discontinued operations, accordingly, the comparative figures were
  reclassified for all periods presented.

F  41

---

---



|                                                           
|-----------------------------------------------------------
|MAGAL SECURITY SYSTEMS LTD.                                
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|            |                                
|----------- | -------------------------------
|NOTE 18:   | DISCONTINUED OPERATIONS (Cont.)

| |    |                                                                                                                   
| | -- | ------------------------------------------------------------------------------------------------------------------
| | b. | The
  following are the results of discontinued operations for the years ended
  December 31, 2004, 2005 and 2006:

| |                            |  |                         |     
| | -------------------------- |  | ----------------------- | ----
| |                            |  | Year ended December 31, |     
| |                            |  |                         |     
| |                            |  | 2004                    |     
| |                            |  |                         |     
| |                            |  |                         |     
| | Revenues                   |  | $                       | 506 
| | Cost of
  revenues         |  |                         | 499 
| |                            |  |                         |     
|
| | Gross profit
  (loss)      |  |                         | 7   
| |                            |  |                         |     
| |                            |  |                         |     
| | Operating
  expenses:      |  |                         |     
| |                            |  |                         |     
| | Sales and
  marketing, net |  |                         | 160 
| |                            |  |                         |     
|
| | Operating
  loss           |  |                         | (153
| |                            |  |                         |     
| | Tax benefit                |  |                         | (32 
| |                            |  |                         |     
|
| | Net loss                   |  | $                       | (121
| |                            |  |                         |     

|            |                             
|----------- | ----------------------------
|NOTE 19:  - | SUBSEQUENT EVENT (UNAUDITED)

| |                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company
  has evaluated the effect of the adoption of FIN 48 (see note 2z) on its
  financial statements, and expects that the adoption of FIN 48 will have an
  effect of approximately $200 on its financial statements.



---

F  42

---

---

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/ Izhar
  Dekel        
| |                               |                          
| | Name:                         | Izhar Dekel              
| | Title:                        | Chief
  Executive Officer
| | Date:                         | June 28,
  2007          

90

---

---