`SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON D.C. 20549

                                    FORM 20-F

[_]  REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G) OF THE SECURITIES
     EXCHANGE ACT OF 1934

                                       OR

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934

          FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

                                       OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934

              FOR THE TRANSITION PERIOD FROM _________ TO _________

                                       OR

[_]  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:
NONE

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

                  ORDINARY SHARES, NIS 1.0 PAR VALUE PER SHARE
                                (Title of Class)

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

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 ............ 10,372,448 (as of
December 31, 2005) Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act.

                               Yes [_]     No [X]`

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

                               Yes [_]     No [X]

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

                               Yes [X]     No [_]

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

   Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]

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

                           Item 17 [_]     Item 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 [_]     No [X]

This Annual Report on Form 20-F is incorporated by reference into the
Registrant's Registration Statements on Form F-3, File Nos. 333-9050 and
333-123265, as amended.`

`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 National Market and on the
Tel Aviv Stock Exchange under the symbol MAGS.

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

     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, 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 July 11, 2006 was NIS
4.387 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                                        12
              A. HISTORY AND DEVELOPMENT OF THE COMPANY                        12
              B. BUSINESS OVERVIEW                                             12
              C. ORGANIZATIONAL STRUCTURE                                      24
              D. PROPERTY, PLANTS AND EQUIPMENT                                24
    ITEM 4A. UNRESOLVED STAFF COMMENTS                                         25
    ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS                      25
              A. OPERATING RESULTS                                             33
              B. LIQUIDITY AND CAPITAL RESOURCES                               39
              C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES                42
              D. TREND INFORMATION                                             43
              E. OFF-BALANCE SHEET ARRANGEMENTS                                43
              F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS                 44
    ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                        45
              A. DIRECTORS AND SENIOR MANAGEMENT                               45
              B. COMPENSATION                                                  47
              C. BOARD PRACTICES                                               48
              D. EMPLOYEES                                                     56
              E. SHARE OWNERSHIP                                               56
    ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                 58
              A. MAJOR SHAREHOLDERS                                            58
              B. RELATED PARTY TRANSACTIONS                                    59
              C. INTERESTS OF EXPERTS AND COUNSEL                              60
    ITEM 8.  FINANCIAL INFORMATION                                             60
              A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION       60
              B. SIGNIFICANT CHANGES                                           61



                                       i`

`ITEM 9.  THE OFFER AND LISTING                                             61
              A.  OFFER AND LISTING DETAILS                                    61
              B.  PLAN OF DISTRIBUTION                                         63
              C.  MARKETS                                                      63
              D.  SELLING SHAREHOLDERS                                         63
              E.  DILUTION                                                     63
              F.  EXPENSES OF THE ISSUE                                        63
    ITEM 10. ADDITIONAL INFORMATION                                            63
              A.  SHARE CAPITAL                                                63
              B.  MEMORANDUM AND ARTICLES OF ASSOCIATION                       63
              C.  MATERIAL CONTRACTS                                           68
              D.  EXCHANGE CONTROLS                                            68
              E.  TAXATION                                                     68
              F.  DIVIDENDS AND PAYING AGENTS                                  80
              G.  STATEMENTS BY EXPERTS                                        80
              H.  DOCUMENTS ON DISPLAY                                         80
              I.  SUBSIDIARY INFORMATION                                       80
    ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK        80
    ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES            82
PART II                                                                        82
    ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                   82
    ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
             USE OF PROCEEDS                                                   82
    ITEM 15. CONTROLS AND PROCEDURES                                           82
    ITEM 16. [RESERVED]                                                        83
    ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                 83
    ITEM 16B. CODE OF ETHICS                                                   83
    ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                           83
    ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE        84
    ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
              PURCHASERS                                                       84
PART III                                                                       84
    ITEM 17.  FINANCIAL STATEMENTS                                             84
    ITEM 18.  FINANCIAL STATEMENTS                                             84
    ITEM 19.  EXHIBITS                                                         84
SIGNATURE                                                                      86

                                       ii`

`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, 2004 and 2005 and for each of the years ended December 31, 2003,
2004 and 2005 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,
2001, 2002 and 2003 and for each of the years ended December 31, 2001 and 2002
from our audited consolidated financial statements not included in this annual
report. 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,
                                                          ----------------------------------------------------------------------
                                                          2001 (*)      2002 (*)        2003 (*)        2004 (*)          2005
                                                          -------       --------        --------        --------        --------
                                                                          (IN THOUSANDS EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues                                                  $40,416       $ 42,376        $ 58,655        $ 60,468        $ 61,282
Cost of revenues                                           21,081         23,458          32,847          33,226          39,154
                                                          -------       --------        --------        --------        --------
Gross profit                                               19,335         18,918          25,808          27,242          22,128
                                                          -------       --------        --------        --------        --------
Operating expenses:
  Research and development, net                             3,054          3,128           4,773           4,683           5,265
  Selling and marketing, net                                7,790          8,511          11,427          12,519          13,180
  General and administrative                                4,949          4,938           5,305           5,771           5,961
   Award granted by principal shareholders                      -              -               -           1,200               -
                                                          -------       --------        --------        --------        --------
Total operating expenses                                   15,793         16,577          21,505          24,173          24,406
                                                          -------       --------        --------        --------        --------
Operating income (loss)                                     3,542          2,341           4,303           3,069          (2,278)
Financial income (expenses), net                               40            199          (1,003)           (762)           (800)
                                                          -------       --------        --------        --------        --------
Income (loss) before income taxes                           3,582          2,540           3,300           2,307          (3,078)
Income taxes (tax benefit)                                    446            646             910           1,133             (23)
                                                          -------       --------        --------        --------        --------
Income (loss) from continuing operations .                  3,136          1,894           2,390           1,174          (3,055)
Gain (loss) from discontinued operations, net                  31             (6)             14            (121)           (156)
                                                          -------       --------        --------        --------        --------
Net income (loss)                                           3,167          1,888           2,404           1,053          (3,211)
                                                          =======       ========        ========        ========        ========
Basic net earnings (loss) per share from continuing
operations                                                $  0.41       $   0.24        $   0.30        $   0.13        $  (0.31)
Basic net loss per share from discontinued
operations                                                      -              -               -           (0.01)          (0.01)
                                                          -------       --------        --------        --------        --------
Basic net earnings (loss)  per share                      $  0.41       $   0.24        $   0.30        $   0.12        $  (0.32)
                                                          =======       ========        ========        ========        ========
Diluted net earnings (loss) per share from
continuing operations                                     $  0.40       $   0.23        $   0.30        $   0.13        $  (0.31)
Diluted net loss per share from discontinued
operations                                                      -              -               -           (0.01)          (0.01)
                                                          -------       --------        --------        --------        --------
Diluted net earnings (loss) per share                     $  0.40       $   0.23        $   0.30        $   0.12        $  (0.32)
                                                          =======       ========        ========        ========        ========
Weighted average number of ordinary shares used in
computing basic net earnings per share                      7,738          7,866           7,948           8,581           9,883
Weighted average number of ordinary shares used in
computing diluted net earnings per share                    7,925          8,069           8,029           8,636           9,900
Cash dividend per share                                   $  0.13       $      -        $   0.05        $      -        $      -
                                                          =======       ========        ========        ========        ========

(*)  Reclassified.

                                       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 eliminate 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,
                                                       ----------------------------------------------------------------
                                                        2001          2002          2003           2004          2005
                                                       -------       -------       -------       -------       --------
                                                                               (IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
 Cash and cash equivalents                             $ 2,738       $ 2,519       $ 4,389       $11,964       $ 10,099
Short and long-term bank deposits and structured
notes                                                   11,849        12,357        12,051         5,994         18,853
Working capital                                         18,391        15,688        21,401        21,603         35,454
Total assets                                            53,347        59,741        71,443        77,976        101,842
Short-term bank credit (including current
maturities of long-term loans)                           6,264        10,357        16,438        17,467         21,715
Long-term bank loans                                     5,038         4,698         1,873         3,500          1,653
Total shareholders' equity                              32,700        35,031        38,984        43,548         56,950

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, 2003, 2004 and 2005, revenues generated from
sales to the Israeli Ministry of Defense, or MOD, accounted for 27.5%, 7.8% and
23.9%, 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 IMPACTED.

     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 submitted by us. 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 bank advanced payment guarantee on June 20, 2006.

     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 has not
yet filed its response. 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.

     On July 11, 2006 the customer made a demand for additional payment under a
bank performance guarantee for $1.4 million. 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. Although we obtained the temporary
injunction, according to our legal counsel, our chances to ultimately prevent
the forfeiture of the guarantee remain unclear. In view of the above and due to
the uncertainty in preventing the forfeiture of the performance bank guarantee,
we included a provision in the amount of $1.4 million in respect of this
guarantee in our financial statements for the year ended December 31, 2005.


                                       3`

`IN THE FUTURE, THE LEVEL OF OUR CONTRACTS MAY BE REDUCED 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:

     o    Their requirements or budgetary constraints change;

     o    they cancel multi-year contracts and related orders if funds become
          unavailable;

     o    they shift spending priorities into other areas or for other products;
          and

     o    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 $15.1 million
in Smart through December 31, 2005. Its operations to date have not been
profitable, and it has an accumulated deficit of $6.7 million as of December 31,
2005. Smart's success will depend upon its ability to penetrate the market for
these services. If Smart is unable to market its services 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.

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.


                                       4`

`In the future:

     o    we may not be successful in developing and marketing new products or
          product features that respond to technological change or evolving
          industry standards;

     o    we may experience difficulties that could delay or prevent the
          successful development, introduction and marketing of these new
          products and features; or

     o    our new products and product features 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% in 2005
and 84.1% in 2004), 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:

     o    unexpected changes in regulatory requirements;

     o    currency fluctuations;

     o    export restrictions, tariffs and other trade barriers;

     o    unexpected difficulties in staffing and managing foreign operations;

     o    longer payment cycles;

     o    difficulties in collecting accounts receivable;

     o    political instability; and

     o    seasonal reductions in business activities.

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

WE ARE ENGAGED IN A HIGHLY COMPETITIVE BUSINESS. IF WE ARE UNABLE TO COMPETE
EFFECTIVELY, OUR REVENUES AND INCOME WILL BE MATERIALLY AND ADVERSELY AFFECTED.

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


                                       5`

`WE MAY BE ADVERSELY AFFECTED BY 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.

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 SUCCESSFUL IN MARKETING AND DEVELOPING MARKETS FOR OUR NEW
PRODUCTS.

     As part of our growth strategy, we developed three new products, DreamBox,
Fortis and PipeGuard. We intend to continue to invest substantial funds in the
marketing and sales of these products. Our marketing and sale efforts may not be
successful, in which case our growth strategy will be harmed.

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 45 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.


                                       6`

`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.

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 JACOB
EVEN-EZRA, OUR CHAIRMAN AND CHIEF EXECUTIVE OFFICER, AND IZHAR DEKEL, OUR
PRESIDENT, THE LOSS OF WHOM WOULD NEGATIVELY AFFECT OUR BUSINESS.

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


                                       7`

`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.

THE IMPLEMENTATION OF SFAS NO. 123(R), WHICH WILL REQUIRE US TO RECORD
COMPENSATION EXPENSE IN CONNECTION WITH EQUITY SHARE-BASED COMPENSATION AS OF
THE FIRST QUARTER OF 2006, MAY REDUCE OUR PROFITABILITY.

     On December 16, 2004, the Financial Accounting Standards Board, or FASB,
issued Statement No. 123 (revised 2004), Share-Based Payment, or SFAS No.
123(R), which is a revision of SFAS No. 123. Generally, the approach in SFAS No.
123(R) is similar to the approach described in SFAS No. 123. However, SFAS No.
123 permitted, but did not require, share-based payments to employees to be
recognized on the basis of their fair values while SFAS No. 123(R) requires, as
of the first quarter of 2006, all share-based payments to employees to be
recognized on the basis of their fair values. SFAS No. 123(R) also revises,
clarifies and expands guidance in several areas, including measuring fair value,
classifying an award as equity or as a liability and attributing compensation
cost to reporting periods. The adoption of SFAS No. 123(R) may have a
significant effect on our results of operations in the future; however, the
impact of its adoption cannot be predicted at this time. In addition, such
adoption could limit our ability to use stock options as an incentive and
retention tool, which could, in turn, negatively impact our ability to recruit
employees and retain existing employees. Had we adopted SFAS 123(R) in 2005, the
impact of that standard would have decreased our net income by approximately
$1.05 million, as described in the disclosure of pro forma net income and
earnings per share in our consolidated financial statements.

COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.

     As a result of changing laws, regulations and standards relating to
accounting, corporate governance and public disclosure, the costs of being a
public company in general have increased in recent years. The Sarbanes-Oxley Act
of 2002 requires changes in some of our corporate governance and securities
disclosure or compliance practices. We expect that the on-going implementation
of these regulations will further increase our legal compliance costs and will
make some activities more time consuming. We are presently evaluating and
monitoring regulatory developments and cannot estimate the magnitude of
additional costs we may incur as a result of such developments. In order to
implement Section 404 of the Sarbanes-Oxley Act of 2002, which governs internal
controls and procedures for financial reporting, we will need to expend
significant management time and financial resources to comply with the
applicable requirements. This and other proposed legislation may increase the
fees of our professional advisors and our insurance premiums.


                                       8`

`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:

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

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

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

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

     o    developments or disputes concerning proprietary rights;

     o    introduction and adoption of new industry standards;

     o    changes in financial estimates by securities analysts;

     o    market conditions or trends in our industry;

     o    changes in the market valuations of our competitors;

     o    announcements by us or our competitors of significant acquisitions;

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

     o    additions or departures of key personnel.

     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. Since September 2000, there has been
a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. These developments have adversely affected the regional peace process,
placed the Israeli economy under significant stress, and have negatively
influenced Israel's relationship with several Arab countries. In August 2005,
Israel evacuated all Israeli settlements in the Gaza Strip and four settlements
in the West Bank. In January 2006, Hamas won the elections in the Palestinian
Authority and as a result the diplomatic relations between Israel and the
Palestinian Authority have worsened. The implications of these developments
cannot at this time be foreseen. 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.


                                       9`

`POLITICAL TRADE RELATIONS COULD LIMIT OUR ABILITY TO SELL OR BUY
INTERNATIONALLY.

     We could be affected adversely by the interruption or reduction of trade
between Israel and its trading partners. Some countries, companies and
organizations continue to participate in a boycott of Israeli firms and others
doing business with Israel or with Israeli companies. To date, these measures
have not had a material adverse affect on our business. In the future,
restrictive laws, policies or practices towards Israel or Israeli businesses may
have an adverse impact on 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.

THE ECONOMIC CONDITIONS IN ISRAEL HAVE NOT BEEN STABLE IN RECENT YEARS.

     In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
deteriorate.

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 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 2001, 2002 and 2005 the rate of devaluation of
the NIS against the dollar was 9.3% 7.3% and 6.8% respectively, while in 2003
and 2004 the NIS appreciated in value in relation to the dollar by 7.6% and
1.6%, 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.


                                       10`

`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.

THE TAX BENEFITS THAT WE CURRENTLY RECEIVE FROM OUR APPROVED ENTERPRISE PROGRAMS
REQUIRE US TO SATISFY SPECIFIED CONDITIONS. IF WE FAIL TO SATISFY THESE
CONDITIONS, WE MAY BE REQUIRED TO PAY ADDITIONAL TAXES AND WOULD LIKELY BE
DENIED THESE BENEFITS IN THE FUTURE.

     The Investment Center of the Ministry of Industry, Trade and Labor of the
State of Israel has granted approved enterprise status to certain of our
manufacturing facilities. Starting from when we begin to generate net income
from these approved enterprise programs, any portion of our income derived from
these approved enterprise programs will be exempt from tax for a period of two
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.

PROVISIONS OF ISRAELI LAW MAY DELAY, PREVENT OR MAKE DIFFICULT AN ACQUISITION OF
US, WHICH COULD PREVENT A CHANGE OF CONTROL AND THEREFORE DEPRESS THE PRICE OF
OUR SHARES.

     Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making more difficult a merger with, or other
acquisition of, us. This could cause our ordinary shares to trade at prices
below the price for which third parties might be willing to pay to gain control
of us. Third parties who are otherwise willing to pay a premium over prevailing
market prices to gain control of us may be unable or unwilling to do so because
of these provisions of Israeli law.

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.


                                       11`

`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.

AS A FOREIGN PRIVATE ISSUER WHOSE SHARES ARE LISTED ON THE NASDAQ National
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 National
Market, we are permitted to follow certain home country corporate governance
practices instead of certain requirements of the NASDAQ Marketplace Rules,
including the composition of our Board of Directors, director nomination
procedure, compensation of officers, distribution of annual reports to
shareholders, and quorum at shareholders' meetings. In addition, we may follow
Israeli law instead of the NASDAQ Marketplace Rules that 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 our company, certain transactions other than a
public offering involving issuances of a 20% or more interest in our 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."

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:


                                       12`

`o    a line of perimeter security systems, which automatically detect and
          locate intruders, identify the nature of intrusions and provide
          emergency notification;

     o    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

     o    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. Since the beginning of 2004, we have
launched three new products, the DreamBox, Fortis and PipeGuard, that
significantly broaden the spectrum of security solutions we offer and
substantially expand our potential security markets.

     ENTER NEW MARKETS AND STRENGTHEN PRESENCE IN EXISTING MARKETS. In 2006 we
intend to continue to penetrate new geographic markets by various means,
including the establishment of alliances with local distributors. 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.
We believe that the three products we launched in 2004 will substantially
broaden our potential markets.

     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:

     o    in-depth threat analysis;

     o    determination of the appropriate hardware and software solutions;

     o    training sessions for systems operators; and

     o    upon customer approval, integration of the required systems into our
          security management and control systems.

     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.


                                       13`

`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:

     o    taut wire perimeter intrusion detection systems;

     o    vibration detection systems; and

     o    field disturbance sensors.

     Our line of perimeter security systems utilizes sophisticated sensor
devices to detect and locate intruders and identify the nature of intrusions.
Our perimeter security systems have been installed along 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.

     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.


                                       14`

`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 systems are sold for between $11-$26 per meter.

     FIELD DISTURBANCE SENSORS. We offer two types of field disturbance sensors.
The Intelli-Field volumetric electronic field disturbance sensor can be
installed outdoors on perimeter systems, buildings or as free-standing units.
The Perimitrax buried volumetric field disturbance sensor can be buried in most
types of soil and paved areas and uses "leaky coax" technology to detect
attempted perimeter penetrations. Both systems detect intrusions before the
intruder touches the sensor. The Intelli-Field system costs approximately
$80-$190 per meter and the Perimitrax system is sold for approximately $65-$170
per meter.

     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 a limited amount of 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.


                                       15`

`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.

     DreamBox 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.

     By developing this product, we entered a new area of activity. 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.

     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 its introduction, we have sold our security management system and
provided turnkey projects to several customers, including large international
companies and international airports.

     At the end of 2002 we won a bid to protect the Otopeni International
Airport in Bucharest, Romania. The contract totals approximately $16 million.
This turnkey project includes different types of security systems as well as
video and data communication systems that will be integrated by MagNet. In March
2004, we signed an extension of the contract for $3.8 million and in August
2004, we signed another extension of the contract for $3.3 million. This
contract, including the extensions, is expected to be completed by December
2006.

     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.


                                       16`

`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 2005, 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.


                                       17`

`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.

     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.


                                       18`

`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 addition we have begun to
invest resources in the distribution of perimeter intrusion detection systems to
private corporations. We attempt to initiate contact with potential customers at
trade shows, where we demonstrate our products and distribute promotional
materials. After initial discussions, we generally seek to provide potential
customers with products on a trial basis or in a small-scale installation. We
believe that this affords prospective purchasers an opportunity to assess our
products over a sustained period of time under realistic conditions. We have
sales offices located in the United Kingdom, Germany, Mexico, the United States,
China, Romania and Poland.

     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.

     For the last two years we have distributed our taut wire detection systems
in the U.S. through our subsidiary Magal Senstar Inc., or MSI, 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, MSI and Senstar Stellar Corporation, or
Senstar, respectively.

     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.


                                       19`

`The following table shows the breakdown of our consolidated revenues for
the calendar years 2003, 2004 and 2005 by operating segment:

                                Year Ended December 31,
                         -----------------------------------
                         2003 (*)     2004 (*)        2005
                         -------       -------       -------
                                    (In thousands)

Perimeter products       $51,077       $46,342       $40,143
Projects                   6,720        11,375        17,970
Video monitoring             403         2,060         2,897
Other                        455           691           272
                         -------       -------       -------
Total                    $58,655       $60,468       $61,282
                         =======       =======       =======

     (*)  Reclassified

CUSTOMERS

     The following table shows the geographical breakdown of our consolidated
revenues for the calendar years 2003, 2004 and 2005:

                                           Year Ended December 31,
                                    -----------------------------------
                                    2003 (*)      2004 (*)       2005
                                    -------       -------       -------
                                              (In thousands)

Israel                              $19,797       $ 9,617       $19,309
U.S.                                 13,292        17,871        13,185
Canada                                6,338         4,068         8,759
Romania                               5,151         9,521         6,244
Europe (excluding Romania)            5,465         9,150         3,691
Others                                8,612        10,241        10,094
                                    -------       -------       -------
Total                               $58,655       $60,468       $61,282
                                    =======       =======       =======

     (*)  Reclassified


     For the years ended December 31, 2003, 2004 and 2005, revenues generated
from sales to the MOD and the IDF, accounted for 27.5%, 7.8% and 23.9%,
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.


                                       20`

`During 2005, we derived less than 5.0% 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.

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 2003, 2004 and 2005 were
approximately $5.1 million, $5.1 million and $5.4 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 6.9%, 8.0% and 3.0% 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:

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

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

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

OFFICE OF THE CHIEF SCIENTIST OF THE ISRAEL MINISTRY OF INDUSTRY, TRADE AND
LABOR

     We have historically sought co-financing of our development projects from
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 $80,000, $61,000 and $83,000 in the years ended December
31, 2003, 2004 and 2005, respectively. As of December 31, 2005, our aggregate
contingent obligation to the OCS amounted to $1.8 million.


                                       21`

`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.

     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 in the years ended December 31, 2003, 2004 and 2005, we have not
paid any royalties. As of December 31, 2005, our aggregate contingent obligation
amounted to $82,000.

BACKLOG

     As of May 31, 2006, our backlog amounted to approximately $20.0 million of
which approximately $12.5 million is expected to be delivered by the end of
2006, $3.0 million is expected to be delivered by the end of 2007 and $4.5
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.

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

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

COMPETITION

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


                                       22`

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

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

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

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

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

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

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

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


                                       23`

`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.

GOVERNMENT REGULATION OF CERTAIN EXPORTS

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

C.   ORGANIZATIONAL STRUCTURE.

     The table below lists our subsidiaries. We, or one of our subsidiaries, own
100% of the outstanding capital stock of the subsidiary.

     Effective as of April 1, 2005, Perimeter Products Inc., one of our wholly
owned U.S. subsidiaries merged into another of our U.S. wholly owned
subsidiaries, Senstar Stellar Inc. Following the merger, Senstar Stellar Inc.'s
name was changed to Magal Senstar Inc., or MSI.

     NAME OF SUBSIDIARY                                COUNTRY OF INCORPORATION
     ------------------                                ------------------------

     Senstar-Stellar Corporation                       Canada

     Magal Senstar Inc.                                United States (Delaware)

     Senstar GmbH                                      Germany

     Kobb Inc.                                         United States (Delaware)

     Magal B.V.                                        The Netherlands

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

     Senstar-Stellar Limited                           United Kingdom

     Smart Interactive Systems, Inc.                   United States (Delaware)

     E.S.E. Ltd.                                       Israel

     Magal Security Sisteme S.R.L                      Romania

     Magal Security Systems Poland                     Poland

D.   PROPERTY, PLANTS AND EQUIPMENT.

     Our two-story 2,533 square meter plant is located on a 4,352 square meter
parcel in the Yehud Industrial Zone. We purchased the rights to the land in
August 1988 from a third party, which had purchased them primarily from the
Israel Land Authority. In accordance with Israeli law, this parcel of land is
still registered in the name of the Israel Land Authority. We will be entitled
to have title to the property recorded in our name when Israeli authorities
subdivide the property into parcels. This procedure is a statutory requirement
for transferring land ownership in Israel. The products that we manufacture at
this facility include our taut-wire intrusion detection systems, our vibration
detection systems, our video-motion detection systems, MagNet, Fortis, DreamBox,
PipeGuard, and other perimeter systems.


                                       24`

`Senstar owns a 33,000 square foot facility in Carp, Ontario, Canada.
Approximately 7,000 square feet are devoted to administrative, marketing and
management functions and approximately 8,000 square feet are used for
engineering, system integration and customer service. Senstar uses the remaining
18,000 square feet for production operations, including cable manufacturing,
assembly, testing, warehousing, shipping and receiving. In December 2004,
Senstar bought an additional 182,516 square feet of vacant land adjacent to this
property for future expansion. Senstar also leases 358,560 square feet of land
near this facility, for $2,500 per year. This area is used as an outdoor sensor
test and demonstration site for its products. The products that Senstar
manufactures at this facility include the Perimitrax/Panther 2000 buried cable
intrusion detection systems, the Intelli-Field electro static detection system,
the Intelli-FLEX microphonic fence detection system, Flash and Flare, and
various perimeter monitoring and control systems.

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

     In connection with two of our credit lines, a fixed charge was placed on
our plant in Israel by each of Bank Leumi Israel and Union Bank of Israel, each
of which ranks pari-passu with the other.

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

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."

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

     o    a line of perimeter security systems, which automatically detect and
          locate intruders, identify the nature of intrusions and provide
          emergency notification;

     o    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

     o    video monitoring services.


                                       25`

`We began to market three new products: DreamBox, PipeGuard and Fortis in
2004. DreamBox is a state-of-the-art embedded hardware and software product,
which integrates a number of CCTV related applications into one box, including
outdoor and indoor video motion detection systems. The system is designed to be
economical, as well as compact to save space, while avoiding the use of
complicated cable installation and network protocols integration. PipeGuard
utilizes an innovative technology to guard buried pipelines, regardless of
pipeline length, with the ability to detect potential attack and alert
authorities before harm or damage occurs. PipeGuard provides a solution for
securing buried assets, gas and oil pipelines and infrastructure of buried
communication lines such as fiber optic cables. The target market for PipeGuard
includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies dealing with security and
environment. Fortis is a security management and control system that integrates
the management, control and display of various security systems, both outdoor,
such as perimeter security systems, and indoor, such as fire detection, entry
monitoring and alarm systems, into a single, real-time database, and supports
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.

     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;
consequently the MOD renewed the work on the southern parts 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 2006. Although we believe that we
will record revenues from the seam line project in 2006, 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.

     During 2005, we continued to incur losses relating to Smart's operations.

     BUSINESS CHALLENGES/AREAS OF FOCUS

     Our primary business challenges and areas of focus include:

     o    continuing the growth of revenues and profitability of our perimeter
          security system line of products;

     o    enhancing the introduction and recognition of our new products into
          the markets;

     o    penetrating into new markets and strengthening our presence in
          existing markets;


                                       26`

`o    succeeding in selling our comprehensive turnkey solutions; and

     o    achieving operating profitability from our Smart subsidiary.

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 on a time-and-materials
basis.

     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 over a period generally
exceeding one year. Such revenues are recognized using contract accounting on a
percentage of completion method. The amounts of revenues recognized are based on
the total fees under the agreements and the percentage to completion achieved in
accordance with the "Input Method."

     Project costs include material purchased to produce the system, related
labor and overhead expenses and subcontractor's costs. We measured the
percentage to completion 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.
Estimates of total project requirements are based on our prior experience in
installing and integrating security systems, our collection experience, delivery
and acceptance of similar services, which are reviewed and updated regularly by
us. 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 our
results of operations when they are reasonably determinable by us, on a
cumulative catch-up basis.

     We believe that the use of the percentage of completion method is
appropriate as we have the ability to make reasonably dependable estimates of
the extent of progress towards completion, contract revenues and contract costs.
In addition, the contracts we execute 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 the event 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.

                                       27`

`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.

     Fees are payable upon completion of agreed upon milestones and subject to
customer acceptance. Amounts recognized in advance of contractual billing,
mainly as a result of using the "Input Method," are recorded as unbilled
accounts receivable. The period between most instances of advanced recognition
of revenues and the customers' billing generally range between one to six
months. At December 31, 2005 we recorded $8.6 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 collectability is probable.

     Services and maintenance are performed under either fixed-price basis or
time-and-materials basis 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 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
collectability is reasonably assured.

     One of our subsidiaries provides security video monitoring services. The
majority of its executed 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. Our
subsidiary's obligation is related to the provision of monitoring services. The
service contracts do not meet the definition of a lease, and as such, the
subsidiary recognizes the monthly service fees over the terms of the contracts.

     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. Such write-offs are included in cost of revenues.
Cost is determined as follows:

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

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

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

     During 2003, 2004 and 2005, we recorded inventory write-offs in the amounts
of $601,000, $224,000 and $507,000, respectively.


                                       28`

`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.

     As part of the process of preparing our consolidated financial statements,
we are required to estimate our income taxes in each of the jurisdictions in
which we operate. This process involves estimating our actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within our consolidated
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and we must establish a valuation
allowance to reduce its deferred tax assets to the amount that is more likely
than not to be realized. Increases in the valuation allowance result in
additional expense to be reflected within the tax provision in the consolidated
statement of income. At December 31, 2005, we had a deferred tax asset of $2.0
million. We have total estimated available carryforward tax losses of $2.4
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 $8.3 million and $944,000, respectively, that may be offset against
future taxable profit for 16-20 years and an indefinite period, respectively. As
of December 31, 2005, 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 acquired in a business combination
on or after July 1, 2001 may not be amortized and we ceased to amortize goodwill
acquired in prior periods beginning January 2002.

     We test goodwill impairment on acquisition and at least annually thereafter
or between annual tests in certain circumstances, we write down goodwill when
impaired, rather than amortizing it as previous accounting standards required.
Goodwill attributable to each of the reporting units is tested for impairment by
comparing the fair value of each reporting unit with its carrying value. Fair
value is determined using discounted cash flow.

     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 2003, 2004 and 2005, no
impairment losses were identified.

     As of December 31, 2005, our goodwill amounted to $4.2 million which
principally relates to our perimeter security systems segment.

     IMPAIRMENT OF LONG LIVED ASSETS

     Our 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 2003,
2004 and 2005, no impairment losses were identified.


                                       29`

`FINANCIAL STATEMENTS IN U.S. DOLLARS

     A significant portion of our revenues is generated in dollars. Financing
and investing activities including credit, loans, equity transactions and cash
investments are executed in dollars. We believe that the dollar is the primary
currency of the economic environment in which we operate. Thus, our functional
and reporting currency is the dollar. The dollar was also determined to be the
functional currency of our U.S.- based subsidiaries.

     Monetary accounts maintained in currencies other than the dollar are
remeasured into dollars. All transaction gains and losses from the remeasured
monetary balance sheet items are reflected in the statement of income as
financial income or expenses, as appropriate.

     The financial statements of all our foreign subsidiaries, excluding our
U.S. subsidiaries, whose functional currency is their local currency, have been
translated into dollars. All balance sheet accounts have been translated using
the exchange rates in effect at the balance sheet date. Statement of income
amounts have been translated using the average exchange rate for the period. The
resulting translation adjustments are reported as a component of shareholders'
equity in accumulated other comprehensive income (loss).

     Accordingly, we had accumulated foreign currency translation income of
approximately $2.3 million and $2.4 million that was included as part of
"accumulated other comprehensive income" within our balance sheets at December
31, 2004 and 2005, respectively. During 2003, 2004 and 2005, foreign currency
translation income of $2.3 million, $1.1 million and $87,000, 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 dollar, these gains would have increased our income for
each of the years presented.

     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, structured notes, unbilled accounts receivable, trade
receivables and long-term trade receivables.

     Of our cash and cash equivalents and short-term and long-term bank deposits
at December 31, 2005, $26.8 million is invested in major Israeli and U.S. banks,
approximately $2.2 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.

     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 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 by a general reserve. In certain circumstances, we may require
letters of credit, other collateral or additional guarantees. As of December 31,
2005, the allowance for doubtful accounts amounted to $306,000.


                                       30`

`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, as
a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign
operation.

     We designate our derivative instruments 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.

     To protect against the change in the forecasted foreign currency cash flows
of certain sale arrangements resulting from changes in the exchange rate during
2003, 2004 and 2005, 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.

     During 2005, we recognized no hedge ineffectiveness for the Euro contract
cash flows hedge as we concluded that the changes in the cash flows attributable
to the changes in the exchange rates were completely offset by the forward
contract.

     We determined that 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, the forward loss was recorded in
financial expenses in 2005.

     During the year ended December 31, 2005, we recognized a net loss of
$368,000 related to the effective portion of our hedging instruments and a net
gain of $442,000 related to the portion of the hedging instrument excluded from
the assessment of hedge ineffectiveness.

     During the year ended December 31, 2004, we recognized a net loss of
$932,000 related to the effective portion of our hedging instruments and a net
loss of $19,000 related to the portion of the hedging instrument excluded from
the assessment of hedge ineffectiveness.

     As of December 31, 2005, we expect to reclassify $6,000 of net income on
derivative instruments from other comprehensive income to earnings during the
next 12 months due to actual sales and related payments.


                                       31`

`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:

     o    The carrying amounts of cash and cash equivalents, 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.

     o    The carrying amount of our long-term trade receivables, long-term bank
          deposits and structured notes 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.

     o    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, 2004, the
          fair value of our long-term borrowings was $5.3 million, compared to
          the carrying amount of $5.4 million. As of December 31, 2005, the fair
          value of our long-term borrowings was $5.3 million, compared to the
          carrying amount of $5.3 million.

     o    The fair value of foreign currency contracts (used for hedge purposes)
          is estimated by obtaining current quotes from investment bankers.

     RECENT ACCOUNTING PRONOUNCEMENTS IN THE UNITED STATES

     On December 16, 2004, the FASB issued SFAS No. 123(R) (revised 2004),
"Share-Based Payment," which is a revision of SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123(R)"). Generally, the approach in SFAS
123(R) is similar to the approach described in SFAS No. 123. However, SFAS 123
permitted, but did not require, share-based payments to employees to be
recognized based on their fair values while SFAS 123(R) requires all share-based
payments to employees to be recognized based on their fair values. SFAS 123(R)
also revises, clarifies and expands guidance in several areas, including
measuring fair value, classifying an award as equity or as a liability and
attributing compensation cost to reporting periods. We adopted SFAS 123(R) on
January 1, 2006.

     SFAS 123(R) permits companies to adopt its requirements using one of the
following two methods:

     o    The "modified prospective" method, in which compensation cost is
          recognized commencing with the effective date (i) based on the
          requirements of SFAS 123(R) for all share-based payments granted after
          the effective date and (ii) based on the requirements of SFAS 123 for
          all awards granted to employees prior to the effective date of SFAS
          123(R) that remain unvested at the effective date.

     o    The "modified retrospective" method, which includes the requirements
          of the modified prospective method described above, but also permits
          entities to restate based on the amounts previously recognized under
          SFAS 123, for purposes of pro forma disclosures all prior periods
          presented.

     As permitted by SFAS 123, we currently account for share-based payments to
employees using APB 25, the intrinsic value method. The impact of the adoption
of SFAS 123(R) cannot be predicted at this time, as it depends on levels of
share-based payments for future grant. However, had we adopted SFAS 123(R) in
2005, the impact of that standard would have decreased our net income by
approximately $1.05 million, as described in the disclosure of pro forma net
income and earnings per share in our consolidated financial statements.

     In March 2005, the SEC Staff issued Staff Accounting Bulletin No. 107 (SAB
107) to give guidance on implementation of SFAS 123(R).


                                       32`

`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,
                                                    2001 (*)   2002 (*)    2003 (*)     2004 (*)      2005
                                                      ---        ---        ----         ----         ----
Revenues                                              100%       100%        100%         100%         100%
Cost of revenues                                       52         56          56           55           64
                                                      ---        ---        ----         ----         ----
Gross profit                                           48         44          44           45           36
                                                      ---        ---        ----         ----         ----
Operating expenses:
  Research and development, net                         8          7           8            8            9
  Selling and marketing, net                           19         20          20           21           21
  General and administrative                           12         11           9            9           10
  Award granted by principal shareholders               -          -           -            2            -
                                                      ---        ---        ----         ----         ----
Operating income                                        9          6           7            5           (4)
Financial income (expenses), net                        -          -          (2)          (1)          (1)
                                                      ---        ---        ----         ----         ----
Income before income taxes                              9          6           5            4           (5)
Income taxes (tax benefit)                              1          2           1            2            -
                                                      ---        ---        ----         ----         ----
Income from continuing operations                       8          4           4            2           (5)
Gain (loss) from discontinued operations, net           -          -           -            -            -
                                                      ---        ---        ----         ----         ----
Net income                                              8%         4%          4%           2%          (5)%
                                                      ---        ---        ----         ----         ----

----------

     *    Reclassified
     -    Less than 1%

YEARS ENDED DECEMBER 31, 2005 AND 2004

     REVENUES. Revenues increased by 1.3% to $61.3 million in the year ended
December 31, 2005 as compared with $60.5 million in the year ended December 31,
2004. Revenues from sales of perimeter systems were $40.1 million in 2005 as
compared with $46.3 million in 2004, a decrease of 13.4%. Revenues from security
turnkey projects increased by 58.0% to $18.0 million in 2005 as compared with
$11.4 million in 2004. Based on our backlog for 2006 of approximately $12.5
million and our assessment of the market, we anticipate that revenue in 2006
will increase compared to our revenues in 2005.

     COST OF REVENUES. Cost of revenues increased to $39.2 million in the year
ended December 31, 2005 as compared with $33.2 million in the year ended
December 31, 2004. Cost of revenues as a percentage of revenues was 63.9% in
2005 as compared with 55.0% in 2004 as a result of changes in the mixture of our
revenues and expenses incurred in connection with the execution of a project in
Eastern Europe that was cancelled, and a provision due to the customer's demand
for the payment under a performance bank guarantee in the amount of $1.4
million. Upon our motion, the District Court in Haifa, Israel has issued a
temporary injunction against the payment of such guarantee pending a hearing in
August 2006. Although we obtained the temporary injunction, according to our
legal counsel, our chances to ultimately prevent the forfeiture of the guarantee
remain unclear. In view of the above and due to the uncertainty in preventing
the forfeiture of the performance bank guarantee, we included a provision in the
amount of $1.4 million in respect of this guarantee in our financial statements.
We anticipate that our cost of revenues as a percentage of revenues will
decrease in 2006.


                                       33`

`GROSS PROFIT. Gross profit decreased to $22.1 million in the year ended
December 31, 2005 as compared with $27.2 million for the year ended December 31,
2004, primarily as a result of expenses incurred in connection with a project in
Eastern Europe that was cancelled. 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,
net for the year ended December 31, 2005 were $5.3 million as compared with $4.7
million for the year ended December 31, 2004, an increase of 12.4%, mainly due
to our continued investment in the products that were launched in 2004 and in
new products. Research and development expenses, net amounted to 8.6% of
revenues in 2005, compared to 7.7% in 2004. Royalty bearing grants and
investment tax credits decreased to $162,000 in 2005 compared to $405,000 in
2004. We expect that our net research and development expenditures as a
percentage of revenues will decrease in 2006.

     SELLING AND MARKETING EXPENSES, NET. Selling and marketing expenses, net
were $13.2 million for the year ended December 31, 2005 as compared with $12.5
million for the year ended December 31, 2004, 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(R), and the increase in commissions paid in connection with our
projects. Selling and marketing expenses amounted to 21.5% and 20.7% of revenues
in each of 2005 and 2004, respectively. We expect that our selling and marketing
expenses as a percentage of revenues will remain at the same level in 2006.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $6.0 million for the year ended December 31, 2005 compared to $5.8 million
for the year ended December 31, 2004. General and administrative expenses
amounted to 9.7% of revenues in 2005 compared to 9.5% in 2004. The increase in
general and administrative expenses was due to an increase of $255,000 in the
amortization of deferred stock compensation. We expect that our general and
administrative expenses will increase in 2006 due to the costs associated with
our implementation of the internal controls required under Section 404 of the
Sarbanes-Oxley Act.

     FINANCIAL EXPENSES, NET. Financial expenses, net for the year ended
December 31, 2005 were $800,000 as compared with $762,000 for the year ended
December 31, 2004.

     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 taxes of $1.1 million for the year ended December 31,
2004.

YEARS ENDED DECEMBER 31, 2004 AND 2003

     REVENUES. Revenues increased by 3.1% to $60.5 million in the year ended
December 31, 2004 as compared with $58.7 million in the year ended December 31,
2003. Revenues from sales of perimeter systems were $46.3 million in 2004 as
compared with $51.1 million in 2003, a decrease of 9.3%, as a result of a
decrease of approximately $10.4 million in the seam-line project, which made a
major contribution to our revenues in 2003 and was halted in 2004 due to
litigation in Israel. Revenues from security turnkey projects increased by 69.3%
to $11.4 million in 2004 as compared with $6.7 million in 2003. One of our main
projects in 2004 was the protection of the Otopeni International Airport in
Romania.


                                       34`

`COST OF REVENUES. Cost of revenues reached $33.2 million in the year ended
December 31, 2004 as compared with $32.8 million in the year ended December 31,
2003. Cost of revenues as a percentage of revenues was 55.0% in 2004 as compared
with 56.0% in 2003.

     GROSS PROFIT. Gross profit increased to $27.2 million in the year ended
December 31, 2004 as compared with $25.8 million for the year ended December 31,
2003, primarily as a result of our increased revenues.

     RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development expenses,
net for the year ended December 31, 2004 were $4.7 million as compared with $4.8
million for the year ended December 31, 2003, a decrease of 2.0%. Research and
development expenses, net amounted to 7.7% of revenues in 2004 as compared with
8.1% in 2003. Royalty bearing grants and investment tax credits increased to
$405,000 in 2004 compared to $355,000 in 2003.

     SELLING AND MARKETING EXPENSES, NET. Selling and marketing expenses, net
were $12.5 million for the year ended December 31, 2004 as compared with $11.4
million for the year ended December 31, 2003, an increase of 9.6%. The increase
in selling and marketing expenses in 2004 was primarily due to increased
marketing and selling expenses for our newly developed products, especially the
DreamBox(R), and increase in commissions paid in connection with our projects.
Selling and marketing expenses amounted to 20.7% of revenues in 2004 as compared
with 19.5% in 2003.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $5.8 million for the year ended December 31, 2004 compared to $5.3 million
for the year ended December 31, 2003. General and administrative expenses
amounted to 9.5% of revenues in 2004 compared to 9.0% in 2003. The increase in
general and administrative expenses was due to an $0.2 million increase in the
amortization of deferred stock compensation expenses and an increase in expenses
incurred by our Smart subsidiary due to a $0.2 million increase in rent and
depreciation expenses arising from its relocation to a new facility.

     AWARD GRANTED BY PRINCIPAL SHAREHOLDERS. Our two principal shareholders
awarded our employees $1.2 million out of their personal funds in celebration of
our twentieth anniversary. According to generally accepted accounting principles
in the United States, such award was recorded in our statement of income as an
expense, although it did not affect our shareholders' equity nor our statement
of cash flows.

     FINANCIAL INCOME (EXPENSES), NET. Financial expenses, net for the year
ended December 31, 2004 were $762,000, as compared with $1 million for the year
ended December 31, 2003 a decrease of 24.0%. This decrease was due to the
decrease in the rate of devaluation of the U.S. dollar against the Canadian
Dollar and the NIS.

QUARTERLY RESULTS OF OPERATIONS

     The following tables set forth certain unaudited quarterly financial
information for the two years ended December 31, 2005. 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.

     Our 2005 quarterly financial information below includes the reversal of
revenues and a corresponding increase in expenses as first reported in our Form
6-K filing of February 2006. As a result of a subsequent to year end
cancellation of a turnkey project by a customer in Eastern Europe, we decided to
reconsider the revenue recognition of this project in our financial statements
for the year ended December 31, 2005. We believe that it is appropriate not to
record the revenues from this project in 2005 and to reduce income accordingly.


                                       35`

`The results of the fourth quarter of 2005 include an expense of $1.4
million due to the Eastern Europe customer's formal demand for the payment under
a performance bank guarantee. (See Item 8: "Financial information- A.
Consolidated Statements and Other Financial Information - Legal proceedings" and
Note 17 to our consolidated financial statements).

                                                                                 Three months ended
                                                ----------------------------------------------------------------------------------------
                                                    JUN. 30, 2005                    SEPT. 30, 2005                 DEC. 31, 2005
                                                ------------------------        ------------------------        ------------------------
                                                   As                             As                               As
                                               previously         As           previously         As           previously          As
                                                reported       adjusted         reported       adjusted        reported         adjusted

CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues                                        $ 17,138        $ 13,238        $ 17,721        $ 15,761        $ 20,038        $ 18,557
Cost of revenues                                   9,705           8,865          10,239           9,817          11,981          13,013
                                                --------        --------        --------        --------        --------        --------
Gross profit                                       7,433           4,373           7,482           5,944           8,057           5,544
                                                --------        --------        --------        --------        --------        --------
Operating expenses:
  Research and development, net                    1,276           1,276           1,337           1,337           1,496           1,496
  Selling and marketing, net                       3,882           3,340           3,775           3,503           3,789           3,611
  General and administrative                       1,438           1,438           1,367           1,367           1,644           1,743
  Award granted by principal shareholders              -               -               -               -               -               -
                                                --------        --------        --------        --------        --------        --------
Total operating expenses                           6,596           6,054           6,479           6,207           6,929           6,850
                                                --------        --------        --------        --------        --------        --------
Operating income (loss)                              837          (1,681)          1,003            (263)          1,128          (1,306)
Financial income (expenses), net                     (37)            (37)           (119)           (119)            111            (315)
                                                --------        --------        --------        --------        --------        --------
Income (loss) before income taxes                    800          (1,718)            884            (382)          1,239          (1,621)
Income taxes (tax benefit)                           294            (170)            260             (27)            412            (144)
                                                --------        --------        --------        --------        --------        --------
Income (loss) from continuing operations             506          (1,548)            624            (355)            827          (1,477)
Loss from discontinued operations,
  net                                                (24)            (24)            (21)            (21)            (80)            (80)
                                                --------        --------        --------        --------        --------        --------
Net income                                           482          (1,572)            603            (376)            747          (1,557)
                                                ========        ========        ========        ========        ========        ========



                                       36`

`Three months ended
                                                  -------------------------------------------------------------------------------------------------------------------------
                                                                            2004*                                                          2005
                                                  ---------------------------------------------------------       ---------------------------------------------------------
                                                   MAR. 31,        JUN. 30,       SEPT. 30,       DEC. 31,        MAR. 31,*       JUN. 30,*      SEPT. 30,*       DEC. 31,
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues                                          $  14,082       $  14,374       $  15,152       $  16,860       $  13,726       $  13,238       $  15,761       $  18,557
Cost of revenues                                      7,779           7,879           8,346           9,222           7,459           8,865           9,817          13,013
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Gross profit                                          6,303           6,495           6,806           7,638           6,267           4,373           5,944           5,544
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Operating expenses:
  Research and development, net                       1,131           1,161           1,193           1,198           1,156           1,276           1,337           1,496
  Selling and marketing, net                          2,587           3,043           2,974           3,915           2,726           3,340           3,503           3,611
  General and administrative                          1,301           1,417           1,415           1,638           1,413           1,438           1,367           1,743
  Award granted by principal shareholders                 -           1,200               -               -               -               -               -               -
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Total operating expenses                              5,019           6,821           5,582           6,751           5,295           6,054           6,207           6,850
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Operating income (loss)                               1,284            (326)          1,224             887             972          (1,681)           (263)         (1,306)
Financial income (expenses), net                        (93)           (258)           (223)           (188)           (329)            (37)           (119)           (315)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Income (loss) before income taxes                     1,191            (584)          1,001             699             643          (1,718)           (382)         (1,621)
Income taxes (tax benefit)                              451             140             310             232             318            (170)            (27)           (144)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Income (loss) from continuing operations                740            (724)            691             467             325          (1,548)           (355)         (1,477)
Loss from discontinued operations,
  net                                                   (53)            (14)            (27)            (27)            (31)            (24)            (21)            (80)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Net income                                              687            (738)            664             440             294          (1,572)           (376)         (1,557)
                                                  =========       =========       =========       =========       =========       =========       =========       =========
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                                       55.2            54.8            55.1            54.7            54.3            67.0            62.3            70.1
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Gross profit                                           44.8            45.2            44.9            45.3            45.7            33.0            37.7            29.9
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Operating expenses:                                                                                                                     0.0             0.0             0.0
  Research and development, net                         8.0             8.1             7.9             7.1             8.4             9.6             8.5             8.1
  Selling and marketing, net                           18.4            21.2            19.6            23.2            19.9            25.2            22.2            19.5
  General and administrative                            9.2             9.9             9.3             9.7            10.3            10.9             8.7             9.4
  Award granted by principal shareholders                 -             8.3               -               -               -               -               -               -
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Total operating expenses                               35.6            47.5            36.8            40.0            38.6            45.7            39.4            36.9
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Operating income (loss)                                 9.1            (2.3)            8.1             5.3             7.1           (12.7)           (1.7)           (7.0)
Financial income (expenses), net                       (0.7)           (1.8)           (1.5)           (1.1)           (2.4)           (0.3)           (0.8)           (1.7)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Income (loss) before income taxes                       8.5            (4.1)            6.6             4.1             4.7           (13.0)           (2.4)           (8.7)
Income taxes  (tax benefit)                             3.2             1.0             2.0             1.4             2.3            (1.3)           (0.1)           (0.8)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------

Income (loss) from continuing operations                5.3            (5.0)            4.6             2.8             2.4           (11.7)           (2.3)           (8.0)

Loss from discontinued operations, net                 (0.4)           (0.1)           (0.2)           (0.2)           (0.2)           (0.2)           (0.1)           (0.4)
                                                  ---------       ---------       ---------       ---------       ---------       ---------       ---------       ---------
Net income (loss)                                       4.9%           (5.1)%           4.4%            2.6%            2.2%          (11.9)%          (2.4)%          (8.4)%
                                                  =========       =========       =========       =========       =========       =========       =========       =========

(*) Reclassified.

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:

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

     o    due to weather and other conditions, 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.


                                       37`

`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 2001, 2002 and 2005, the rate of
devaluation of the NIS against the dollar was 9.3%, 7.3% and 6.8% respectively,
while in 2003 and 2004 the NIS appreciated in value in relation to the dollar by
7.6% and 1.6%, 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:

                                                         Israeli inflation
 Year ended     Israeli inflation   NIS devaluation   adjusted for devaluation
December 31,         rate %             rate %                 %
-----------     -----------------   ---------------   ------------------------
    2001              1.4                9.3                 (7.9)
    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)

     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 three years ended December 31,
2005, foreign currency fluctuations had an adverse impact on our results of
operations, and our foreign exchange losses, net were ($569,000), ($120,000) and
($145,000), respectively. 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
2003, 2004 and 2005 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.

     During 2005, we recognized no hedge ineffectiveness for the Euro contract
cash flows hedge as we concluded that the changes in the cash flows attributable
to the changes in the exchange rates were completely offset by the forward
contract.

     We determined that 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, the forward loss was recorded in
financial expenses in 2005.

     As of December 31, 2005, we expect to reclassify $6,000 of net income on
derivative instruments from other comprehensive income to earnings during the
next 12 months due to actual sales and related payments.


                                       38`

`EFFECTIVE CORPORATE TAX RATE

     Israeli companies are generally subject to income tax on their worldwide
taxable income. The applicable rate for 2005 was 34%, which was reduced to 31%
in 2006, and will be further reduced to 29% in 2007, 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, 2005, our subsidiaries in the United States and the
United Kingdom had estimated total available carry forward tax losses of $8.3
million and $944,000, 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.

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 $15.2 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
$21.6 million at December 31, 2004. Cash and cash equivalents amounted to $10.1
million at December 31, 2005 compared to $12.0 million at December 31, 2004.
Short-term and long-term bank deposits and structured notes amounted to $18.9
million at December 31, 2005 compared to $6.0 million at December 31, 2004. Our
cash and cash equivalents, short and long-term bank deposits and a structured
note are held mainly in U.S. dollars.


                                       39`

`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, structured note and our expected cash flow from
operations in 2006 will be sufficient to meet our planned and potential cash
requirements through 2006.

CASH FLOWS

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

                                                                           YEARS ENDED DECEMBER 31,
                                                                   ---------------------------------------
                                                                     2003           2004            2005
                                                                   -------        --------        --------
                                                                               (in thousands)

Net cash provided by (used in) continuing operations               $ 1,705        $  3,988        $ (3,820)
Net cash provided by (used in) discontinued operations                  19            (310)           (319)
                                                                   -------        --------        --------
Net cash provided by (used in) operating activities                  1,724           3,678          (4,139)
Net cash provided by (used in) investing activities                 (3,606)            512         (15,248)
Net cash provided by  financing  activities                          3,500           3,096          17,269
Effect of exchange rate changes on cash and cash equivalents           252             289             253
                                                                   -------        --------        --------
Increase (decrease) in cash and cash equivalents                     1,870           7,575          (1,865)
Cash and cash equivalents at the beginning of the year               2,519           4,389          11,964
                                                                   -------        --------        --------
Cash and cash equivalents at the end of the year                   $ 4,389        $ 11,964        $ 10,099
                                                                   -------        --------        --------

     Net cash used in operating activities was ($4.1) million for the year ended
December 31, 2005 compared to net cash provided by operating activities of $3.7
million and $1.7 million for the years ended December 31, 2004 and 2003,
respectively. The decrease in cash from operations was primarily due to losses
incurred in 2005 as a result of expenses related to the project in Eastern
Europe which was cancelled and to the increase in revenues in 2005 attributable
to the seam line project. A large portion of the seam line project was recorded
in the second half of 2005, and a substantial portion of the billing under this
project was collected in the first six months of 2006. Purchases of property and
equipment in 2003, 2004 and 2005 were $3.2 million, $4.9 million and $2.7
million, respectively. Capital expenditures in 2003, 2004 and 2005 were
principally for equipment for Smart, computers and other machinery and
equipment. We estimate that our capital expenditures for 2006 will total
approximately $2.7 million, of which 65% will be spent in Israel, 30% in the
U.S. and Canada and 5% 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 for 2006 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.

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 $39.6 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 and MTB:

     o    A ratio of at least 40% of shareholders' equity out of the
          consolidated total assets;


                                       40`

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

     o    The same shareholders maintain the core of control in our company.

     We have also undertaken to maintain the same financial ratios in respect of
our long term credit line with Union Bank, which credit line was not used as of
December 31, 2005.

     As of December 31, 2005, we were not in compliance with the requirement
under our credit lines with BLL and MTB that we will have a minimum annual
consolidated net income of $1 million. BLL has agreed to waive such requirement
for 2005 and informed us that it will not require the immediate repayment of our
outstanding indebtedness as a result of such non-compliance. While we have not
received a formal waiver from MTB to date, we believe that such waiver will be
obtained within the next few weeks. As of December 31, 2005, the balance of
short-term bank credit due to MTB amounted to approximately $2.4 million.

     If we fail to fulfill our undertakings and covenants as aforesaid, these
three banks will be entitled to demand the immediate repayment of any of our
outstanding indebtedness to them and may terminate our credit lines with them.
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 $9.3 million in the
aggregate.

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

     o    A quick ratio of not less than 1.25;

     o    A ratio of total liabilities to tangible net worth of not greater than
          0.75; and

     o    Tangible net worth of at least $9.0 million.

     o    As of December 31, 2005, Senstar was in compliance with these ratios
          and terms.

     As of December 31, 2005, we had approximately $12.0 million available under
our credit lines. In addition, our subsidiaries had approximately $3.8 million
available under their credit lines.

     As of December 31, 2005, our outstanding balance under our credit lines
consisted of:

     o    Short-term NIS-denominated loans of approximately $1.7 million,
          bearing an average interest at a rate of 5%;

     o    Short-term dollar-denominated loans of approximately $15.1 million,
          bearing an average interest at a rate of 4.1%;

     o    Short-term Polish Zloty-denominated loan of approximately $1.2
          million, bearing an average interest at a rate of 5.9%;

     o    Several bank performance and advance payment guarantees totaling
          approximately $8.6 million, at an annual cost of 0.5%-1.0%; and

     o    Forward contracts of approximately $1.1 million.


                                       41`

`As of December 31, 2005, our subsidiaries had outstanding, in the
aggregate, $5.3 million in long-term loans as follows:

     o    $2.5 million, bearing interest at a fixed annual rate of 3.1%. The
          interest on the outstanding balance under this loan is due monthly.
          This loan is due in one installment in April 2006;

     o    $500,000, bearing interest at an annual rate of 5.6% and
          collateralized by the assets of our US subsidiary, Magal Senstar Inc.,
          or MSI. This loan is due in one installment in April 2006;

     o    $500,000, bearing interest at an annual rate of 5.2% and
          collateralized by MSI's assets. This loan is due in one installment in
          April 2006;

     o    $820,000 to MSI, bearing interest at a fixed rate of 5.5%. The loan is
          due in 20 quarterly installments of $47,200, commencing February 2006.
          We have guaranteed the full amount of this loan; and

     o    $980,000 to MSI, bearing interest at a fixed rate of 5.5%. 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 have
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 0.3% until
the minimum deposit is maintained.

     As of December 31, 2005, Senstar GmbH obtained bank performance guarantees
in the amount of $130,000.

     As of December 31, 2005, Senstar issued a letter of credit in the amount of
$96,000 in connection with the purchase of supplies.

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,
2003, 2004 and 2005, we obtained $139,000 $228,000 and $8,000, 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 $80,000, $61,000 and $83,000 in the
years ended December 31, 2003, 2004 and 2005, respectively.

     As of December 31, 2005, we had a contingent obligation to pay royalties of
approximately $1.8 million to the OCS upon the successful sale of products
developed using such research and development programs sponsored by the OCS.


                                       42`

`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 from the Fund and, during the years ended December 31, 2003, 2004 and
2005, we did not pay any royalties. As of December 31, 2005, we had a remaining
contingent obligation to the Fund of $82,000.

INVESTMENT TAX CREDIT

     Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
the years ended December 31, 2003, 2004 and 2005, Senstar recognized $216,000,
$177,000 and $153,000, respectively, of investment tax credits as a reduction of
research and development expenses. Senstar has available investment tax credits
of approximately $249,000 to reduce future federal Canadian income taxes
payable. These credits will expire at various dates from 2014 through 2015. 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, 2005, 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, 2005
and March 31, 2006 were $8.7 million and $8.0 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; however, on July 11, 2006 a customer made demand for the payment
under a bank performance guarantee in the amount of $1.4 million, for which we
have recorded a provision in our financial statements for the year ended
December 31, 2005. On our motion, the District Court in Haifa, Israel has issued
a temporary injunction against the payment of such guarantee pending a hearing
in August 2006. Although we obtained the temporary injunction, according to our
legal counsel, our chances to ultimately prevent the forfeiture of the guarantee
remain unclear. In view of the above and due to the uncertainty in preventing
the forfeiture of the performance bank guarantee, we included a provision in the
amount of $1.4 million in respect of this guarantee in our financial statements.

                                       43`

`F.   TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.

     The following table summarizes our minimum contractual obligations and
commercial commitments as of December 31, 2005 and the effect we expect them to
have on our liquidity and cash flow in future periods.


      Contractual Obligations                                         Payments due by Period
      -----------------------                                         ----------------------
                                                                 less than 1                                  more than 5
                                                   Total            year          1-2 Years       3-5 Years      years
                                                   -----            ----          ---------       ---------      -----

Long-term debt obligations                      $5,300,000       $3,647,000       $318,000       $1,335,000      $ -
Capital (finance) lease obligations                      -                -              -                -        -
Operating lease obligations                        821,000          404,000        380,000           37,000        -
Purchase obligations                               300,000                -        300,000                -        -
Other long-term liabilities reflected on
   the company's balance sheet under U.S.
   GAAP                                                  -                -              -                -        -
                                                ----------       ----------       --------       ----------      ---
Total                                           $6,421,000       $4,051,000       $998,000       $1,372,000      $ -
                                                ==========       ==========       ========       ==========      ===


                                       44`

`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       75       Chairman of the Board and Chief Executive Officer
Izhar Dekel           54       President and Director
Chaim Porat           70       Vice President - Far East and Australia Marketing
Yehezkel Farber       65       Vice President - Operations
Zvi Dank              56       Vice President - Research and Development
Raya Asher            38       Vice President - Finance, Chief Financial Officer and Secretary
Asaf Even-Ezra        40       Vice President - Israel and West European Marketing
Dany Pizen            54       Vice President - East European and CIS Marketing
Ofer Katz             57       Vice President - Aviation Security
Raffi Netzer          43       Vice President - Africa and Latin America Marketing
Nathan Kirsh          74       Director
Jacob Nuss            58       Director
Jacob Perry           62       Director
Zeev Livne            61       Director
Shaul Kobrinsky       54       Outside Director
Anat Winner           47       Outside Director

     Messrs. Even-Ezra, Dekel, Kirsh, Nuss, Perry and Livne will serve as
directors until our 2006 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 2008 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 and chief executive
officer since 1984, and from 1987 until 1990 he also served as our president. He
is currently a member of the Executive Council and the Management Committee of
Tel-Aviv University. From 1985 to 1988, Mr. Even-Ezra was also chairman of the
Israel Export Institute. Mr. Even-Ezra holds a B.Sc. in Electrical Engineering
from Israel Institute of Technology, or the Technion.

     IZHAR DEKEL has served as our president since 1990 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.

     CHAIM PORAT has served as our vice president - Far East and Australian
marketing since 1988. Prior to joining us, Mr. Porat served as the head of the
security division of Beta Engineering Ltd. Mr. Porat holds a B.Sc. in Electrical
Engineering from the Technion.

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


                                       45`

`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. Pizan 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.

     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 81.5% of the ordinary shares of our company
that are held by Mira Mag Inc. Mr. Kirsh holds a B.A. 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.

     JACOB PERRY was appointed to serve as a director in December 2002. From
1995 to December 2002, Mr. Perry was President and CEO of Cellcom Israel Ltd.,
Israel's largest cellular phone operator. Mr. Perry served 29 years 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. and Lipman Electronic Engineering Ltd. 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.


                                       46`

`ZEEV LIVNE was appointed to serve as a director in 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 Attache 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 was appointed to serve as an outside director in 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 was appointed to serve as an outside director in July 2004.
Mrs. Winner has been a business advisor since 2003. Mrs. Winner served from
October 2001 to July 2004 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.
Previously, and since 1995, Mrs. Winner served as chief financial officer of
Eurocom Cellular Communications Ltd., an Israeli company that is engaged in
importing and marketing cellular phones. 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
for 15 years.

B.   COMPENSATION.

     During the fiscal year ended December 31, 2005, 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. We also have
a key-man life insurance policy for Jacob Even-Ezra, of which we are the
beneficiary.

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

     Under the Israeli Companies Law, the board of directors must approve all
compensation arrangements for the chief executive officer of the company, and
unless provided otherwise in the company's articles of association, all
compensation arrangements for officers and employees (other than the company's
directors) are subject to the chief executive officer's approval. Directors'
compensation arrangements (other than outside directors) also require audit
committee approval before board approval and shareholder approval. However,
pursuant to amendments to the Companies Regulations (Relief from Related Party
Transactions), 5760-2000, directors' compensation and employment arrangements do
not require, in certain circumstances, shareholder approval. In addition, under
these regulations, if the director or office holder is a controlling shareholder
of the company, then the employment and compensation arrangements of such
director or office holder do not require shareholder approval if such
arrangements meet certain criteria.

     An 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.


                                       47`

`During 2005, we granted options for the purchase of total of 53,500
ordinary shares to certain of our directors and executive officers. During 2004,
we granted options to purchase 94,500 ordinary shares to certain of our
directors and executive officers. We have no service contracts with any of our
directors to provide services as a director that provide for benefits upon
termination of employment. However, we do have employment agreements with
certain of our directors in connection with their service as employees.

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.

ELECTION OF DIRECTORS AND OFFICERS

     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, including the outside directors, were elected by
our shareholders at our annual general meeting of shareholders of July 2005.

     Under a recent amendment to 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."


                                       48`

`DIRECTORS' SERVICE CONTRACTS

     Two of our directors, 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 2005, our board of directors, subject to
shareholders approval, extended the appointment of Mr. Even-Ezra as chairman of
the board until January 2008 and as chief executive officer for such period
until a new chief executive officer is appointed,. Under the Israeli Companies
Law, such dual positions require shareholders, approval which must be renewed
every three years. Our shareholders approved this dual position in July 2004. 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 of
employment in July 2004. See also Item 6.B. "Directors, Senior Management and
Employees-Compensation" above.

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. No person may be appointed as an outside director if, at the time of the
appointment or during the two years that preceded the appointment, the person or
the person's relative, partner, employer or an entity of which he is a
controlling shareholder had an interest in the company, in a person who was a
controlling shareholder of the company at the time of the appointment, or in an
entity which was controlled by the company or its controlling shareholder at the
time of the appointment or during the two years that preceded the appointment.

     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 an outside director or may otherwise interfere
with the person's ability to serve as an outside director. If, at the time
outside directors are to be appointed, all current members of the board of
directors are of the same gender, then at least one outside director must be of
the other gender.

     According to a March 2005 amendment to the Israeli Companies Law, effective
as of January 2006, at least one of the outside directors must be an "accounting
and financial expert" and the other outside directors must be "professional
experts," as such terms are defined by regulations promulgated under the Israeli
Companies Law. This requirement does not apply to outside directors appointed
prior to the March 2005 amendment, however a company can not renew the
appointment of any such outside director for an additional term unless the
outside director is (i) an accounting and financial expert or (ii) a
professional expert and at the time the appointment is to be renewed, an outside
director who is an accounting and financial expert serves on the board of
directors.

     The outside directors are elected by shareholders. 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. Outside directors serve for
a three-year term, which may be renewed for only one additional three-year term.
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. 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.


                                       49`

`INDEPENDENT DIRECTORS

     In general, under NASDAQ Stock Market Rules a majority of our Board of
Directors must qualify as independent directors within the meaning of the NASDAQ
Marketplace Rules and our 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, 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 rules of the Securities and
Exchange Commission, we have the mandated three independent directors, as
defined by the Securities and Exchange Commission and NASDAQ rules, on our audit
committee.

     Our Board of Directors has determined that Ms. Winner and Mr. Kobrinsky
qualify both as independent directors under the Securities and Exchange
Commission and NASDAQ requirements and as outside directors under the Israeli
Companies Law requirements. Our Board of Directors has further determined that
Messrs. Nuss and Livne qualify as independent directors under 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, approving related-party transactions as
required by Israeli law, 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
qualifies as a financial expert. The audit committee meets at least once each
quarter. Our audit committee charter is available on our website at
www.magal-ssl.com.

INTERNAL AUDITOR

     Under the Israeli Companies Law, the board of directors must appoint an
internal auditor proposed by the audit committee. The role of the internal
auditor is to examine whether the company's actions comply with the law,
integrity and orderly business procedure. Under the 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.


                                       50`

`APPROVAL OF SPECIFIC RELATED-PARTY TRANSACTIONS

     The Israeli Companies Law imposes a duty of care and a duty of loyalty on
all office holders of a company, including directors and executive officers. The
duty of care requires an office holder to act with the level of competence at
which a reasonable office holder would employ under the same circumstances,
including. An office holder's duty of care includes a duty to use reasonable
means to obtain:

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

     o    all other important information pertaining to these actions.

     The duty of loyalty requires an officer holder to act in good faith and in
the company's interest. The duty of loyalty includes a duty to:

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

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

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

     o    disclose to the company any information or documents relating to the
          company's affairs which the office holder has received by virtue of
          his position in the company.

     Each person listed as a director or executive officer in the table under
"Item 6.A. Directors, Senior Management and Employees -- Directors and Senior
Management" above is an office holder. Under the Israeli Companies Law, all
arrangements as to compensation of executive office holders who are not
directors require approval of the chief executive officer, and the compensation
of office holders who are directors must be approved by our audit committee,
board of directors and shareholders.

     The Israeli Companies Law requires that an office holder promptly disclose
any personal interest that he may have and all related material information
known to him in connection with any existing or proposed transaction by the
company. If the transaction is an extraordinary transaction, that 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, the office holder must also disclose any personal
interest held by:

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

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

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


                                       51`

`In some cases, including in the case of an extraordinary transaction, such
a transaction, action and arrangement must be approved by the audit committee
and by the board of directors itself, and further shareholder approval is
required to approve the terms of compensation of an office holder who is a
director. An office holder who has a personal interest in a matter, which is
considered at a meeting of the board of directors or the audit committee, may
not be present during the board of directors or audit committee discussions and
may not vote on this matter, unless the majority of the members of the board or
the audit committee have a personal interest, as the case may be.

     Under the Israeli Companies Law, the disclosure requirements that apply to
an office holder also apply to a controlling shareholder of a public company. A
controlling shareholder is a shareholder that holds 25% or more of the voting
rights in a public company, provided no other shareholder owns more than 50% of
the voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest,
(including private offerings in which a controlling shareholder has a personal
interest) and a transaction with a controlling shareholder or his relative
regarding terms of service and employment, require the approval of the audit
committee, the board of directors and the shareholders of the company. The
shareholder approval for such transactions must include either at least
one-third of the shareholders who have no personal interest in the transaction
and are present and voting on the matter, in person, by proxy or by written
ballot, at the meeting, or a majority of the voting power present and voting on
the matter, provided that the shareholders who have no personal interest in the
transaction who vote against the transaction do not represent more than one
percent of the voting rights in the company. For a discussion of certain Israeli
Companies Law regulations pertaining to tender offers by shareholders, see Item
10.B. "Additional Information-Memorandum and Articles of Association-Provisions
Restricting a Change in Control of Our Company."

     The Israeli Companies Law requires that every shareholder that
participates, either in person or by proxy, in a vote regarding a transaction
with a controlling member of the company indicate whether or not he or she has a
personal interest in the vote in question, the failure of which results in the
invalidation of that shareholder's vote. Regulations promulgated under the
Israeli Companies Law provide that this requirement does not apply to a company
whose shares are publicly traded outside of Israel if, pursuant to applicable
foreign securities laws, the company is required to distribute a proxy
statement.

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

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

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

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


                                       52`

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

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

     In addition, pursuant to amendment to these regulations, directors'
compensation and employment arrangements do not require shareholder approval,
provided certain criteria are met. Also, pursuant to this amendment, if the
director or the office holder is a controlling shareholder of the company, then
the employment and compensation arrangements of such director or office holder
do not require shareholder approval, provided certain criteria are met.

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

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

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

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

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

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

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

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

     The Israeli Companies Law further provides that a shareholder shall refrain
from oppressing other shareholders. In addition, any controlling shareholder,
any shareholder who knows that it possesses the power to determine the outcome
of a shareholder vote and any shareholder who, pursuant to the provisions of a
company's articles of association, has the power to appoint or prevent the
appointment of an office holder in the company, or has any other power over the
company, is under a duty to act with fairness towards the company and can be
personally liable for a breach of such duty.


                                       53`

`INDEMNIFICATION OF DIRECTORS AND OFFICERS AND LIMITATIONS OF LIABILITY

     EXCULPATION OF OFFICE HOLDERS. Israeli law allows a company, if permitted
by its articles of association, to exculpate an office holder in advance, in
whole or in part, from liability for damages sustained by a breach of duty of
care to the company, except with respect to a breach of his or her 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)
the breach of his or her duty of care to the company or another person; (ii) a
breach of his or her 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 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 pursuant to a 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 financial liability in lieu of criminal
proceedings, or concluded without the filing of an indictment against the office
holder and a financial 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
crime 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 financial 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.

     LIMITATIONS ON EXCULPATION, INSURANCE AND INDEMNIFICATION. These provisions
are specifically limited in their scope by Israeli law, which provides that a
company may not indemnify an office holder, nor exculpate an office holder, nor
enter into an insurance contract which would provide coverage for any monetary
liability, incurred as a result of certain improper actions.

     The term "office holder" of a company includes a director, general manager
or chief executive officer, a vice president or any officer who reports directly
to the general manager or chief executive officer of a company and any other
person assuming the responsibilities of any of the foregoing positions without
regard to such person's title.


                                       54`

`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 shareholders approved our entering into an agreement to indemnify our
office holders up to $5 million, in advance. We currently maintain a directors
and officers liability insurance policy with a per claim and aggregate coverage
limit of $5 million.

     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.

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, without the
need to seek individual exemptions from NASDAQ. 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:

     o    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."

     o    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."

     o    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.

     o    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.



                                       55`

`o    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, 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.

     As of December 31, 2003, we employed 288 full-time employees, of whom 24
were employed in general management and administration, 51in marketing, 49 in
production management, 114 in production, installation and maintenance, and 50
in engineering and research and development. Of our 288 full-time employees, 120
were employed in Israel, 61 were employed in the U.S., 79 were employed in
Canada and 28 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.

     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 July 11,
2006.


                                       56`

`Number of Ordinary Shares  Percentage of Outstanding
          Name                           Owned(1)             Ordinary Shares(2)
------------------------                 ---------                  ------
Jacob Even-Ezra(3)(6)(7)                   348,969                   3.33%
Izhar Dekel(4)(7)                          154,427                   1.47%
Raffi Netzer                                     -                      -
Chaim Porat                                      -                      -
Yehezkel Farber                                  -                      -
Zvi Dank                                         -                      -
Raya Asher                                       -                      -
Asaf Even-Ezra(6)                          121,426                   1.16%
Dany Pizen                                       -                      -
Ofer Katz                                        -                      -
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)         2,608,775                  24.77%

----------

*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 10,390,248ordinary shares issued and
     outstanding as of July 11, 2006.

(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.

     As of July 11, 2006, the 16 directors and executive officers listed above,
as a group, held options to purchase 142,800 of our ordinary shares at a
weighted average exercise price of $7.96 per share. Out of such options 94,500
options expire in January 2009 and 48,300 options 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.


                                       57`

`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, 2005, options to purchase 343,000 shares were
outstanding and additional options to purchase 299,676 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 July 11, 2006, 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.

                                         Number of
                                       Ordinary Shares    Percentage of
                                        Beneficially       Outstanding
 Name                                     Owned(1)      Ordinary Shares(2)
--------------------------------         ---------            ------
Nathan Kirsh (3)                         1,832,227            17.63%
Mira Mag Inc.(4)                         1,485,852            14.30%
Clough Capital Partners L.P. (5)           663,069             6.38%
Diker Management LLC (6)                   612,077             5.89%

----------

(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 10,390,248 ordinary shares issued and
     outstanding as of July 11, 2006.

(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 on information provided by Clough Capital Partners L.P. in a filing
     with the Securities and Exchange Commission, dated December 31, 2005.

(6)  Based on information provided by Diker Management LLC in a filing with the
     Securities and Exchange Commission, dated November 18, 2005.


                                       58`

`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.

MAJOR SHAREHOLDERS VOTING RIGHTS

     Our major shareholders do not have different voting rights.

RECORD HOLDERS

     Based on a review of the information provided to us by our transfer agent,
as of July 11, 2006, there were 61 holders of record of our ordinary shares, of
which 49 record holders holding approximately 0.2% of our ordinary shares had
registered addresses in the United States and 10 record holders holding
approximately 16.4% 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 Company (the central
depositary for the U.S. brokerage community), which held approximately 76.0% of
our outstanding ordinary shares as of said date.

B.   RELATED PARTY TRANSACTIONS.

     In 2003 Mira Mag Inc., our then controlling shareholder, and Jacob
Even-Ezra purchased IAI'S interest in our company.

     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.

REGISTRATION RIGHTS AGREEMENT

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


                                       59`

`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, 2003, 2004 and 2005 were $108,000, $386,000 and
$671,000 respectively.

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 2005, our board of directors, subject to the approval of our
shareholders, extended the appointment of Mr. Even-Ezra as chairman of the board
until January 2008 and as chief financial officer for such period until a new
CEO is appointed. Under the Israeli Companies Law, such dual positions require
shareholders' approval which must be renewed every three years. Our shareholders
approved this dual position in July 2004. 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 2005, the total amount of our revenues from our facilities located
outside of Israel to customers outside of Israel was approximately $34 million,
or 55.7% of our total revenues. The total amount of our export revenues from our
Israeli facilities to countries outside of Israel was approximately $7.8
million, or 12.8% of our total revenues.

LEGAL PROCEEDINGS

     In April 2003, Rav-Tec Ltd. filed a civil action against us, the MOD and
Mr. Giora Cohen in the District Court of Tel-Aviv. The plaintiff alleges that
its failure in the field trials of the perimeter systems executed by the MOD
during 1996-1997 resulted from intentional damage to its perimeter system and
diversion of the results of certain intrusion tests made by Cohen who was then a
soldier in the IDF. The plaintiff alleges that we were the employer of Cohen
during 1995 and we still employed him as our agent during the field trials. The
plaintiff requests the courts to annul the field trial and award it
approximately $714,000 in damages. We have denied all of the above allegations
and claimed that the plaintiff's perimeter system failure was not the result of
Cohen's actions. According to our legal counsel, we have good defenses against
the aforementioned claims. The action has been forwarded to mediation.


                                       60`

`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 submitted by us. 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
bank advance payment guarantee, on June 20, 2006.

     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.
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 has not yet filed its
response. 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.

     On July 11, 2006, the customer made a demand for additional payment under a
bank performance guarantee for $1.4 million. 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. Although we obtained the temporary
injunction, according to our legal counsel, our chances to ultimately prevent
the forfeiture of the guarantee remain unclear.

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

DIVIDEND POLICY

     In 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, 2005.

ITEM 9. THE OFFER AND LISTING

A.   OFFER AND LISTING DETAILS.

ANNUAL STOCK INFORMATION

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


                                       61`

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

                                     NASDAQ NATIONAL MARKET                   TEL AVIV STOCK EXCHANGE
                                    -------------------------                --------------------------
                                     HIGH                LOW                 HIGH                  LOW
                                    -----                ----                -----                -----
 2001                               15.20                2.87         NIS    64.00          NIS   20.50
 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

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 National Market
and the Tel Aviv Stock Exchange:

                                     NASDAQ NATIONAL MARKET                   TEL AVIV STOCK EXCHANGE
                                    -------------------------                --------------------------
                                     HIGH                LOW                 HIGH                  LOW
                                    -----                ----                -----                -----
2004
First Quarter                      $23.22               $6.75             NIS 88.10            NIS 32.25
Second Quarter                      40.35               12.35                156.68                56.77
Third Quarter                       19.45               12.60                 84.77                57.12
Fourth Quarter                      17.05               10.60                 74.70                47.20

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 64.25            NIS 40.61
Second Quarter                     $13.36               $9.01                 61.15                40.57

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
National Market and the Tel Aviv Stock Exchange:

                                      NASDAQ NATIONAL MARKET                  TEL AVIV STOCK EXCHANGE
                                    -------------------------                --------------------------
                                     HIGH                LOW                 HIGH                  LOW
                                    -----                ----                -----                -----
2006
January                            $11.80              $ 8.75            NIS 53.18           NIS 40.61
February                            12.68               10.40                56.06               48.61
March                               14.20               12.05                64.25               58.95
April                               13.36               10.70                61.15               49.64
May                                 11.49                9.31                49.91               42.95
June                                10.70                9.01                47.34               40.57


                                       62`

`B.   PLAN OF DISTRIBUTION.

     Not applicable.

C.   MARKETS.

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

D.   SELLING SHAREHOLDERS.

     Not applicable.

E.   DILUTION.

     Not applicable.

F.   EXPENSES OF THE ISSUE.

     Not applicable.

ITEM 10. ADDITIONAL INFORMATION

A.   SHARE CAPITAL.

     Not applicable.

B.   MEMORANDUM AND ARTICLES OF ASSOCIATION.

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

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.


                                       63`

`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."

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

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

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

SHARE CAPITAL

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

     DIVIDENDS

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

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

     Dividends may be paid only out of our distributable earnings, as defined in
the 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.


                                       64`

`VOTING RIGHTS

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

     o    amend the memorandum or the articles of association;

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

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

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

     RIGHTS IN THE COMPANY'S PROFITS

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

     LIQUIDATION

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

     REDEMPTION

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

     TRANSFER OF SHARES

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


                                       65`

`SUBSTANTIAL LIMITATIONS ON SHAREHOLDERS

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

     CAPITAL CALLS

     Under our memorandum of association and the 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

     An annual general meeting of shareholders is held at least once every
calendar year, not later than 15 months after the last annual general meeting of
shareholders, at such time and at such place as may be fixed by the board of
directors. Any additional general meetings of shareholders are called
"extraordinary general meetings." The board of directors may, in its discretion,
convene an extraordinary general meeting and is obliged to do so upon receipt of
a written request from the holders of at least 5% of our outstanding ordinary
shares and/or of our voting rights.

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

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

LIMITATIONS ON THE RIGHT TO OWN OUR SECURITIES

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


                                       66`

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

     The Companies Law also provides that an acquisition of shares in a public
company on the open market must be made by means of a tender offer if as a
result of the acquisition the purchaser would become a 25% or greater
shareholder of the company. However, this rule does not apply if there already
is another 25% or greater shareholder of the company. Similarly, the Israeli
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if as a result of the acquisition the purchaser
would hold greater than a 45% interest in the company, unless there is another
shareholder holding more than a 45% interest in the company. These requirements
do not apply if, in general, the acquisition (1) was made in a private placement
that received shareholder approval, (2) was from a 25% or greater shareholder of
the company which resulted in the acquiror becoming a 25% or greater shareholder
of the company, or (3) was from a shareholder holding more than a 45% interest
in the company which resulted in the acquiror becoming a holder of more than a
45% interest in the company.

     However, under the Companies Law, if as a result of any acquisition of
shares the acquirer would hold more than 90% of the company's outstanding
shares, the acquisition must be made by means of a tender offer for all of the
outstanding shares. If less than 5% of the outstanding shares are not tendered
in the tender offer, all the shares that the acquirer offered to purchase will
be transferred to the acquirer. The Israeli Companies Law provides for appraisal
rights if any shareholder files a request in court within three months following
the consummation of a full tender offer. If more than 5% of the outstanding
shares are not tendered in the tender offer, then the acquiror may not acquire
shares in the tender offer that will cause his shareholding to exceed 90% of the
outstanding shares. These rules do not apply if the acquisition is made by way
of a private placement, provided such private placement is approved by the
shareholders of the company. In addition, these rules do not apply to a company
whose shares are publicly traded outside of Israel if applicable foreign
securities laws restrict the acquisition of any level of control of the company
or require the purchaser to make a tender offer to the public shareholders upon
the acquisition of any level of control of the company.

DISCLOSURE OF SHAREHOLDERS' OWNERSHIP

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


                                       67`

`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.

GENERAL CORPORATE TAX STRUCTURE

     Israeli companies are subject to income tax on their worldwide 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 is scheduled to decline to
31% in 2006, 29% in 2007, 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."


                                       68`

`LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959

     GENERAL

     The Law for the Encouragement of Capital Investments, 1959, commonly
referred to as the Investment Law, provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the
Ministry of Industry, 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 relate only to taxable income attributable to the
specific approved enterprise. If a company has more than one approval or only a
portion of its capital investments is approved, its effective tax rate is the
result of a weighted average of the applicable rates.

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

     TAX BENEFITS

     Taxable income of a company derived from an approved enterprise is
generally subject to company tax at the maximum rate of 25%, rather than 31%,
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.

     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.


                                       69`

`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.

     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.


                                       70`

`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.

     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.

LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969

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

     o    Deduction, under certain conditions, of purchases of know-how and
          patents over an eight-year period for tax purposes;


                                       71`

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

     o    accelerated depreciation rates on equipment and buildings; and

     o    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, on or after January 1, 2003, on a recognized stock market outside
          of Israel.

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

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

LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND DEVELOPMENT, 1984

     Under the Law for the Encouragement of Industrial Research and Development,
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
non-Israeli 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.


                                       72`

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

TAXATION UNDER INFLATIONARY CONDITIONS

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

     o    There is a special tax adjustment for the preservation of equity
          whereby some corporate assets are classified broadly into fixed assets
          and non-fixed assets.

     o    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.

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


                                       73`

`STAMP TAX

     Under the Stamp Tax on Documents Law, certain documents are subject to
stamp tax. Promulgated regulations provide for a gradual phase-out of the stamp
tax by 2008. A new regulation abolished the Stamp Tax for documents signed after
January 1, 2006. We may be liable to pay stamp tax with respect to documents
that were signed in the period beginning June 1, 2003 and ending on December 31,
2005. Based on the advice of our counsel, our management believes that the
potential costs arising from this matter are not material.

CAPITAL GAINS TAX ON SALES OF OUR ORDINARY SHARES

     As of January 1, 2003, when the recent Israeli tax reform came into effect,
individuals and companies on which the provisions of the income tax law
(Inflationary Adjustments), 1985 are not imposed, are subject to a 15% tax rate
on the real capital gains derived on or after January 1, 2003 from the sale of
shares in Israeli companies publicly traded on a recognized stock exchange
outside of Israel. This will be the case so long as our securities remain listed
on NASDAQ or traded on a stock exchange in Israel or another country.

     Under a recent amendment to the income tax ordinance, effective as of
January 1, 2003 and with respect to sales of shares on or after January 1 2006,
individuals are subject to a 20% tax rate on the real capital gains derived on
or after January 1, 2003 from the sale of shares. 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.
Companies on which the provisions of the income tax law (Inflationary
Adjustments), 1985 were not imposed before January 1, 2006 are subject to 25%
tax rate on real capital gains derived on or after January 1, 2003 from the sale
of the shares. Notwithstanding the above, companies on which the provisions of
the income tax law (Inflationary Adjustments), 1985 were imposed before January
1, 2006 are subject to regular corporate tax rate on real capital gains derived
on the sale of the shares.

     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 non-Israeli 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:

     o    The capital gain is not attributable to a permanent establishment in
          Israel.

     o    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.


                                       74`

`TAXATION OF NON-RESIDENT HOLDERS OF SHARES

     Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends 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
non-residents.

     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 non-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%.

TAX REFORM

     On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No.132), 5762-2002, known as the Tax Reform, came into effect,
following its enactment by the Israeli Parliament on July 24, 2002.

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

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

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

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

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


                                       75`

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

     The material consequences of the amendment applicable to our company
include, among other things, imposing a tax upon all income of Israeli
residents, individuals and corporations, regardless of the territorial source of
the income and certain modifications in the qualified taxation tracks of
employee stock options. In addition, a foreign tax credit was introduced,
allowing us to credit the income tax paid by our subsidiaries abroad against our
tax liabilities on dividends paid to us by such subsidiaries.

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.


                                       76`

`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.

     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 income or, in the case of
certain U.S. Holders, financial services income for United States foreign tax
credit purposes. U.S. Holders should note that recently enacted legislation
eliminates the "financial services income" category with respect to taxable
years beginning after December 31, 2006. Under this legislation, the foreign tax
credit limitation categories will be limited to "passive category income" and
"general category income." 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 passive foreign investment companies, 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.


                                       77`

`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 amounts 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.

     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:

     o    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,


                                       78`

`o    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,

     o    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

     o    you would be required to make 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.


                                       79`

`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.

INTEREST RATE RISK

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


                                       80`

`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 MATURITY
                                           WEIGHTED AVERAGE INTEREST RATE
                                            (U.S. DOLLARS IN THOUSANDS)
                                                                                                          FAIR
                                                                                                         VALUE AT
                                                                                                         DECEMBER
                                          2006             2007        2008     2009-2010    TOTAL       31, 2005
                                       ----------          ----        ----       -----    ----------    -------
LIABILITIES:
Short Term Loans                       $   18,068             -           -           -    $   18,068    $18,068
Weighted Average Interest Rate               4.62%            -           -           -          4.62%         -
Long Term Loans                        $    3,647           155         163       1,335    $    5,300    $ 5,259
Weighted Average Interest Rate               3.83%         5.45%       5.45%       5.45%         4.33%         -

FOREIGN CURRENCY EXCHANGE RISK

     We sell most of our products in North America, Europe and Israel. The
majority of our revenues and expenditures are denominated in dollars. A portion
of our revenues in Israel are made in NIS, and we expect to make NIS denominated
revenues in 2006 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 2006, the NIS has appreciated by
approximately 3.6% 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. In 2001,2002 and 2005, the rate of devaluation of
the NIS against the dollar was 9.3% and 7.3% and 6.8%, respectively, while in
2003 and 2004 the NIS was revaluated in relation to the dollar by 7.6% and 1.6%,
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.

     During the years ended December 31, 2003, 2004 and 2005, foreign currency
fluctuations had an adverse impact on our results of operations, and our foreign
exchange (losses), net were ($569,000), ($120,000) and ($145,000), respectively.
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
2003, 2004 and 2005, 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.


                                       81`

`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.

     During 2005, we recognized no hedge ineffectiveness for the Euro contract
cash flows hedge as we concluded that the changes in the cash flows attributable
to the changes in the exchange rates were completely offset by the forward
contract.

     We determined that 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, the forward loss was recorded in
financial expenses in 2005.

     As of December 31, 2005, we expect to reclassify $6,000 of net income on
derivative instruments from other comprehensive income to earnings during the
next 12 months due to actual sales and related payments.

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

     Our management, including our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures
(as defined in 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 to ensure that
information required to be disclosed by our company in reports that we file or
submit under the U.S. Securities Exchange Act of 1934, as amended, 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
was made known to them by others within the company, as appropriate to allow
timely decisions regarding required disclosure.


                                       82`

`ITEM 16. [RESERVED]

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 in Item 401(h) of Regulation S-K. 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 independent public accountants and the percentage of each of the
fees out of the total amount paid to the 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,
                                               -------------------------
                                                 2004             2005
                                               --------         --------
               Services Rendered                 Fees             Fees
        --------------------------------       --------         --------
        Audit (1)                              $275,311         $266,936
        Audit-related (2)                        17,404           10,000
        Tax (3)                                  18,183           45,100
        Other (4)                                19,380          184,124
                                               --------         --------
        Total                                  $330,278         $506,160

----------

     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:
          attest services that are not required by statute or regulation;
          accounting consultation and audits in connection with mergers,
          acquisitions and divestitures; employee benefit plans audits; and
          consultation concerning financial accounting and reporting standards.

     3.   Tax fees relate to services performed by the tax division for tax
          compliance, planning, and advice.

     4.   Other fees in 2005 include mainly fees related to our public offering.


                                       83`

`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.

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 2005.

                                    PART III

ITEM 17. FINANCIAL STATEMENTS

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

ITEM 18. FINANCIAL STATEMENTS

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

ITEM 19. EXHIBITS

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

 EXHIBIT
    NO.        DESCRIPTION
----------     -----------------------------------------------------------------

  1.1*         Memorandum of Association of the Registrant

  1.2**        Articles of Association of the Registrant

  2.1***       Specimen Share Certificate for Ordinary Share

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


                                       84`

`EXHIBIT
    NO.        DESCRIPTION
----------     -----------------------------------------------------------------

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

   8           List of Subsidiaries of the Registrant

  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, Sainz - 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.

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


                                       85`

`MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2005

                                 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-43`

`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,
2004 and 2005, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2005. 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% of total consolidated assets as of December
31, 2005, and whose revenues constitute approximately 4.6% of total consolidated
revenues for the year ended December 31, 2005. The financial statements of this
company were audited by other auditors, whose reports have been furnished to us,
and our opinion, insofar as it relates to amounts included for this subsidiary,
is based solely on the reports 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 reports of the other auditors provide a reasonable basis for our
opinion.

     In our opinion, based on our audits and the reports 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, 2004 and 2005, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States.


Tel-Aviv, Israel
February 22, 2006 (except Note 17             KOST FORER GABBAY & KASIERER
dated July 13, 2006)                        A Member of Ernst & Young Global


                                     F - 2`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                                                                                                DECEMBER 31,
                                                                                          ------------------------
                                                                                            2004            2005
                                                                                          -------         --------
    ASSETS

CURRENT ASSETS:
  Cash and cash equivalents                                                               $11,964         $ 10,099
  Short-term bank deposits                                                                      -           17,053
  Trade receivables (net of allowance for doubtful accounts of $ 320 and $ 306 at
    December 31, 2004 and 2005, respectively)                                            *)15,102           24,012
  Unbilled accounts receivable                                                           *) 5,595            8,596
  Other accounts receivable and prepaid expenses                                            3,858            4,455
  Deferred income taxes                                                                       488            1,187
  Inventories (Note 3)                                                                     12,702           11,110
                                                                                          -------         --------

TOTAL current assets                                                                       49,709           76,512
                                                                                          -------         --------

LONG-TERM INVESTMENTS AND RECEIVABLES:
  Long-term trade receivables                                                                 344              290
  Long-term bank deposits                                                                   2,994            1,800
  Structured notes                                                                          3,000                -
  Severance pay fund                                                                        2,142            2,070
                                                                                          -------         --------

TOTAL long-term investments and receivables                                                 8,480            4,160
                                                                                          -------         --------

PROPERTY AND EQUIPMENT, NET (Note 4)                                                       14,659           15,587
                                                                                          -------         --------

DEFERRED INCOME TAXES                                                                         186              828
                                                                                          -------         --------

OTHER INTANGIBLE ASSETS, NET (Note 5)                                                         656              569
                                                                                          -------         --------

GOODWILL                                                                                    4,286            4,186
                                                                                          -------         --------

TOTAL assets                                                                              $77,976         $101,842
                                                                                          =======         ========

*)   Reclassified.

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,
                                                                                          ---------------------------
                                                                                            2004              2005
                                                                                          --------          ---------
    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Short-term bank credit (Note 6)                                                         $ 15,618          $  18,068
  Current maturities of long-term debt (Note 8)                                              1,849              3,647
  Trade payables                                                                             3,189              6,360
  Customer advances                                                                              -              3,990
  Other accounts payable and accrued expenses (Note 7)                                       6,669              8,914
  Unrealized losses on hedging forward contracts                                               781                 79
                                                                                          --------          ---------

TOTAL current liabilities                                                                   28,106             41,058
                                                                                          --------          ---------

LONG-TERM LIABILITIES:
  Unrealized losses on hedging forward contracts                                               650                 50
  Long-term bank debt (Note 8)                                                               3,500              1,653
  Accrued severance pay                                                                      2,172              2,131
                                                                                          --------          ---------

TOTAL long-term liabilities                                                                  6,322              3,834
                                                                                          --------          ---------

COMMITMENTS AND CONTINGENT LIABILITIES (Note 9)

SHAREHOLDERS' EQUITY (Note 10):
  Share capital -
    Ordinary shares of NIS 1 par value -
      Authorized: 19,748,000 shares at December 31, 2004 and 2005; Issued and
      outstanding: 8,672,448 and 10,372,448 shares at December 31, 2004 and 2005,
      respectively                                                                           2,825              3,220
  Additional paid-in capital                                                                32,526             47,509
  Deferred stock compensation                                                                 (477)               (38)
  Accumulated other comprehensive income                                                     1,639              2,435
  Retained earnings                                                                          7,035              3,824
                                                                                          --------          ---------

TOTAL shareholders' equity                                                                  43,548             56,950
                                                                                          --------          ---------

TOTAL liabilities and shareholders' equity                                                $ 77,976          $ 101,842
                                                                                          ========          =========

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,
                                                                         -------------------------------------------
                                                                         *) 2003         *) 2004             2005
                                                                         -------         --------          --------

Revenues                                                                 $58,655         $ 60,468          $ 61,282
Cost of revenues                                                          32,847           33,226            39,154
                                                                         -------         --------          --------

Gross profit                                                              25,808           27,242            22,128
                                                                         -------         --------          --------

Operating expenses:
  Research and development, net (Note 15a)                                 4,773            4,683             5,265
  Selling and marketing, net                                              11,427           12,519            13,180
  General and administrative                                               5,305            5,771             5,961
  Award granted by principal shareholders                                      -            1,200                 -
                                                                         -------         --------          --------

TOTAL operating expenses                                                  21,505           24,173            24,406
                                                                         -------         --------          --------

Operating income (loss)                                                    4,303            3,069            (2,278)
Financial expenses, net (Note 15b)                                         1,003              762               800
                                                                         -------         --------          --------

Income (loss) before income taxes                                          3,300            2,307            (3,078)
Income taxes (tax benefit) (Note 12)                                         910            1,133               (23)
                                                                         -------         --------          --------

Income (loss) from continuing operations                                   2,390            1,174            (3,055)
Gain (loss) from discontinued operations, net (Note 16)                       14             (121)             (156)
                                                                         -------         --------          --------

Net income (loss)                                                        $ 2,404         $  1,053          $ (3,211)
                                                                         =======         ========          ========

Basic net earnings (loss) per share from continuing operations           $  0.30         $   0.13          $  (0.31)

Basic net loss per share from discontinued operations                          -            (0.01)            (0.01)
                                                                         -------         --------          --------

Basic net earnings (loss) per share (Note 11)                            $  0.30         $   0.12          $  (0.32)
                                                                         =======         ========          ========

Diluted net earnings (loss) per share from continuing operations         $  0.30         $   0.13          $  (0.31)

Diluted net loss per share from discontinued operations                        -            (0.01)            (0.01)
                                                                         -------         --------          --------

Diluted net earnings (loss) per share (Note 11)                          $  0.30         $   0.12          $  (0.32)
                                                                         =======         ========          ========

*)   Reclassified.

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


                                     F - 5`

`MAGAL SECURITY SYSTEMS LTD.
                                                           AND ITS SUBSIDIARTIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)

                                                                                                                           ACCUMULATED
                                                                                         ADDITIONAL       DEFERRED            OTHER                            TOTAL            TOTAL
                                                       NUMBER OF         ORDINARY         PAID-IN          STOCK          COMPREHENSIVE      RETAINED      COMPREHENSIVE     SHAREHOLDERS'
                                                        SHARES            SHARES          CAPITAL       COMPENSATION      INCOME (LOSS)      EARNINGS          INCOME          EQUITY
                                                      ----------       ------------       -------       -------------       -------        ------------       ---------       --------

Balance as of January 1, 2003                          7,666,370       $      2,600       $21,791       $          (3)      $(1,006)       $     11,649                       $ 35,031
  Declared dividend                                            -                  -             -                   -             -                (401)                          (401)
  Exercise of stock options                              137,446                 30           432                   -             -                   -                            462
  Amortization of deferred stock compensation            231,963                  -             -                   3             -                   -                              3
  Stock dividend                                               -                 53         1,875                   -             -              (1,928)                             -
  Comprehensive income:
    Net income                                                 -                  -             -                   -             -               2,404       $   2,404          2,404
    Unrealized losses on forward contracts, net                -                  -             -                   -          (807)                  -            (807)          (807)
    Foreign currency translation adjustments                   -                  -             -                   -         2,292                   -           2,292          2,292
                                                      ----------       ------------       -------       -------------       -------        ------------       ---------       --------
  Total comprehensive income                                                                                                                                  $   3,889
                                                                                                                                                              =========

Balance as of December 31, 2003                        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 compensation
    related to officers' options grant                         -                  -             -                 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 compensation
    related to officers' options grant                         -                  -             -                 439             -                   -                            439
  Deferred taxes on stock options                              -                  -           190                   -             -                   -                            190
  Comprehensive income:
    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 income                                                                                                                                  $  (2,415)
                                                                                                                                                              =========

Balance as of December 31, 2005                       10,372,448       $      3,220       $47,509       $         (38)      $ 2,435        $      3,824                       $ 56,950
                                                      ==========       ============       =======       =============       =======        ============                       ========

Accumulated unrealized earnings on forward
  contracts, net                                                                                                            $     5
Accumulated foreign currency translation
  adjustments                                                                                                                 2,430
                                                                                                                            -------
Accumulated other comprehensive income as of
  December 31, 2005                                                                                                         $ 2,435
                                                                                                                            =======

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,
                                                                           --------------------------------------
                                                                             2003          2004            2005
                                                                           -------        -------        --------
CASH FLOWS FROM OPERATING ACTIVITIES:

  Net income (loss)                                                        $ 2,404        $ 1,053        $ (3,211)
  Adjustments required to reconcile net income (loss) to net
    cash provided by (used in) operating activities:
    Loss (gain) from discontinued operations                                   (14)           121             156
    Depreciation and amortization                                            1,378          1,966           1,964
    Gain on sale of property and equipment                                      (9)           (18)            (10)
    Decrease (increase) in accrued interest on short-term and
        long-term bank deposits                                               (199)           657            (322)
    Amortization of deferred stock compensation                                  3            184             439
    Decrease (increase) in trade receivables, net                         *)(2,977)      *) 3,956          (8,998)
    Decrease in receivables from related parties                                28              -               -
    Decrease (increase) in unbilled accounts receivable                   *) 1,533       *)(4,130)         (2,819)
    Decrease (increase) in other accounts receivable and prepaid
      expenses                                                                (836)            16            (599)
    Decrease (increase) in deferred income taxes                               (88)           178          (1,020)
    Decrease (increase) in inventories                                      (2,581)          (552)          1,676
    Decrease (increase) in long-term trade receivables                       1,210            (44)             54
    Increase (decrease) in trade payables                                       49         (1,953)          3,096
    Increase in other accounts payable and accrued expenses                  1,727            880           2,194
    Increase in customer advances                                                -              -           3,990
    Accrued severance pay, net                                                  77             (2)             31
    Award granted by principal shareholders                                      -          1,200               -
    Realized losses (gains) on hedging forward contract                          -            476            (441)
                                                                           -------        -------        --------

Net cash provided by (used in) continuing operations                         1,705          3,988          (3,820)
Net cash provided by (used in) discontinued operations                          19           (310)           (319)
                                                                           -------        -------        --------

Net cash provided by (used in) operating activities                          1,724          3,678          (4,139)
                                                                           -------        -------        --------

CASH FLOWS FROM INVESTING ACTIVITIES:

  Purchase of short-term deposits                                                -              -         (16,731)
  Purchase of long-term bank deposits                                            -         (3,000)              -
  Proceeds from sale of long-term deposits                                       -              -           1,194
  Purchase of structured notes                                              (3,000)             -               -
  Redemption of structured notes                                                 -              -           3,000
  Proceeds from sale of short-term bank deposits                             3,505          8,400               -
  Proceeds from sale of property and equipment                                  33             59              71
  Purchase of property and equipment                                        (3,194)        (4,858)         (2,736)
  Purchase of know-how and patents                                             (48)           (89)            (46)
  Acquisition of the business activity of Dominion Wireless Inc. (a)          (902)             -               -
                                                                           -------        -------        --------

Net cash provided by (used in) investing activities                         (3,606)           512         (15,248)
                                                                           -------        -------        --------
*)   Reclassified.

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,
                                                                         ---------------------------------------
                                                                           2003           2004            2005
                                                                         -------        --------        --------
CASH FLOWS FROM FINANCING ACTIVITIES:

  Short-term bank credit, net                                              3,098           2,895           2,402
  Proceeds from long-term bank loans                                          43               -           1,800
  Principal payment of long-term bank loans                                 (103)           (365)         (1,849)
  Proceeds from exercise of employee stock options                           462             967               -
  Proceeds from issuance of shares, net                                        -               -          14,916
  Dividend paid                                                                -            (401)              -
                                                                         -------        --------        --------

Net cash provided by financing activities                                  3,500           3,096          17,269
                                                                         -------        --------        --------

Effect of exchange rate changes on cash and cash equivalents                 252             289             253
                                                                         -------        --------        --------

Increase (decrease) in cash and cash equivalents                           1,870           7,575          (1,865)
Cash and cash equivalents at the beginning of the year                     2,519           4,389          11,964
                                                                         -------        --------        --------

Cash and cash equivalents at the end of the year                         $ 4,389        $ 11,964        $ 10,099
                                                                         =======        ========        ========

SUPPLEMENTAL DISCLOSURES OF CASH FLOWS ACTIVITIES:

  Cash paid during the year for:

      Interest                                                           $ 1,099        $  1,093        $    828
                                                                         =======        ========        ========

      Taxes                                                              $ 1,544        $  1,164        $    887
                                                                         =======        ========        ========
NON-CASH ACTIVITIES:

  Declared dividend                                                      $   401        $      -        $      -
                                                                         =======        ========        ========

(a) ACQUISITION OF THE BUSINESS ACTIVITY OF DOMINION WIRELESS
     INC.:

          Net fair value of the assets acquired at the acquisition
            date was as follows:

          Inventories                                                    $   376
          Property and equipment                                              90
          Technology                                                         436
                                                                         -------

                                                                         $   902
                                                                         =======

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

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 and Israel.

          As for major customer data, see Note 14b.

     b.   Acquisition of the business activity of Dominion Wireless Inc.:

          On July 1, 2003, a subsidiary of the Company acquired the business
          activity of Dominion Wireless Inc. ("DW") for a total consideration of
          $ 902 (including $ 74 in transaction costs), paid in cash.

          The Asset Purchase Agreement with DW, stipulated for additional
          payments to be made conditioned upon the achievement of operating
          income milestones during the periods ending on December 31, 2003, 2004
          and 2005. Since such goals were not met, no additional payments were
          due.

          DW develops, manufactures, sells and supports personal duress alarm
          systems that locate an individual with accuracy and reliability in
          correctional and other institutions. The acquisition of the business
          activity of DW expanded the Company's product line offerings and
          enabled it to provide its customers a comprehensive range of security
          systems.

          The acquisition was accounted for under the purchase method of
          accounting in accordance with SFAS No. 141, and accordingly, the
          purchase price has been allocated to the assets acquired based on
          their estimated fair values at the date of acquisition.

          Based upon a valuation of tangible and intangible assets acquired, the
          Company's subsidiary allocated the total cost of the acquisition to
          the assets acquired, as follows:

                                      JULY 1,
                                       2003
                                       ----
                                     UNAUDITED
                                       ----

          Inventories                  $376
          Property and equipment         90
          Technology                    436
                                       ----

                                       $902
                                       ====

          *)   Reclassified.

                                     F - 9`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)

NOTE 1:- GENERAL (CONT.)

          The value assigned to the tangible and intangible assets has been
          determined as follows:

          1.   DW's inventories and property and equipment are presented at
               current replacement cost.

          2.   The value assigned to technology was determined using the Income
               Approach on the basis of the present value of cash flows
               attributable to the intellectual property over its expected
               future life. Technology is amortized on a straight-line basis
               over a period of 8 years.

          The results of operations of DW have been included in the consolidated
          financial statements since July 1, 2003.

          The following unaudited pro forma information does not purport to
          represent what the Group's results of operations would have been had
          the acquisition been consummated on January 1, 2003, nor does it
          purport to represent the Group's results of operations for any future
          period. Pro forma results of operations for the period:

                                                 YEAR ENDED
                                                DECEMBER 31,
                                                   2003
                                                 ---------

          Revenues                               $ 59,227*)
                                                 =========

          Net income                             $   1,910
                                                 =========

          Basic net earnings per share           $    0.24
                                                 =========

          Diluted net earnings per share         $    0.24
                                                 =========

          *)   Reclassified.

     c.   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".


                                     F - 10`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

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:

          Significant portion of the Company's revenues is generated in U.S.
          dollars ("dollars"). Financing and investing activities including
          credit, loans, equity transactions and cash investments are executed
          in dollars. The Company's management believes that the dollar is the
          primary currency of the economic environment in which the Company
          operates. Thus, the functional and reporting currency of the Company
          is the dollar.

          The dollar was also determined to be the functional currency of the
          Company's U.S. subsidiaries.

          Accordingly, monetary accounts maintained in currencies other than the
          dollar are remeasured into dollars in accordance with SFAS No. 52,
          "Foreign Currency Translation". All transaction gains and losses from
          the remeasured monetary balance sheet items are reflected in the
          statement of income as financial income or expenses, as appropriate.

          The financial statements of all foreign subsidiaries whose functional
          currency is their local currency, excluding the U.S. ones, have been
          translated into dollars. All balance sheet accounts have been
          translated using the exchange rates in effect at the balance sheet
          date. Statement of income amounts have been translated using the
          average exchange rate for the year. The resulting translation
          adjustments are reported as a component of shareholders' equity in
          accumulated other comprehensive income (loss).

     c.   Principles of consolidation:

          The consolidated financial statements include the accounts of the
          Company and its wholly-owned subsidiaries. Intercompany balances and
          transactions including intercompany sales not yet realized outside the
          Group, 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.


                                     F - 11`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     e.   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. The deposit is in U.S.
          dollars, bears interest of 4.75% and matures in 2010.

     f.   Structured notes:

          During 2003, the Company purchased structured notes ("the Notes") at
          par value totaling $ 3,000 to be settled in 2013. Under the terms of
          the Notes, the Notes bear interest of 10% for the first year.
          Thereafter, interest is determined based on six months LIBOR rates
          using the following formula: 10% minus two times six months LIBOR
          rate. The Notes are callable immediately after accumulating 12%
          interest payments.

          The Company accounts for its investment in structured notes in
          accordance with SFAS No. 115, "Accounting for Certain Investments in
          Debt and Equity Securities" and FASB Emerging Issues Task Force Issue
          ("EITF") No. 96-12, "Recognition of Interest Income and Balance Sheet
          Classification of Structured Notes". Management determines the
          appropriate classification of its investments in debt securities at
          the time of purchase and reevaluates such determinations at each
          balance sheet date. Structured notes securities are classified as
          held-to-maturity since management believes the Company has the intent
          and ability to hold these securities to maturity and are stated at
          amortized cost. As of December 31, 2004, the investments in the Notes
          approximate their fair market value. During 2005, the notes were fully
          repaid.

     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. Such write-offs are included in cost of revenues.

          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 2003, 2004 and 2005, the Group recorded inventory write-offs in
          the amount of $ 601, $ 224 and $ 507, respectively.


                                     F - 12`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     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                                                  4
          Machinery and equipment (including machinery
             and equipment leased to customers under
             operating leases)                              10 - 33 (mainly 10%)
          Motor vehicles                                            15
          Promotional display                                    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".

          Know-how is amortized over 8 to 10 years, patents are amortized over a
          period of 10 years and technology is amortized over 8 years.

     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 2003, 2004 and 2005, no impairment losses have been identified.


                                     F - 13`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     l.   Goodwill:

          Goodwill represents excess of the costs over the net fair value of the
          assets of the businesses acquired. Under SFAS No, 142, goodwill
          acquired in a business combination on or after July 1, 2001, shall not
          be amortized, and goodwill acquired in prior periods ceased to be
          amortized since January 1, 2002.

          SFAS No. 142 requires goodwill to be tested for impairment on adoption
          and at least annually thereafter or between annual tests in certain
          circumstances, and written down when impaired, rather than being
          amortized as previous accounting standards required. Goodwill
          attributable to each of the reporting units is tested for impairment
          by comparing the fair value of each reporting unit with its carrying
          value. Fair value is determined using discounted cash flows.
          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 2003, 2004 and 2005, no impairment losses have been identified.

          Differences between the balance of goodwill as of December 31, 2004
          and 2005 derive from functional currency translation adjustments. The
          entire goodwill balance relates to the Perimeter 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 over one year. Such revenues 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, in
          accordance with the "Input Method". The amounts of revenues recognized
          are based on the total fees under the agreements and the percentage to
          completion achieved.


                                     F - 14`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

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. Estimates of total project
          requirements are based on prior experience of installing and
          integrating security systems, a history of no collection issues,
          delivery and acceptance of similar services and a history of no
          cancellation problems, which are reviewed and updated regularly by
          management. 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.

          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.

          Fees are payable upon completion of agreed upon milestones and subject
          to customer acceptance. Amounts recognized in advance of contractual
          billing, mainly as a result of using the "Input Method", are recorded
          as unbilled accounts receivable. The period between most instances of
          advanced recognition of revenues and the customers' billing generally
          range 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 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 collectability is probable.


                                     F - 15`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          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 collectibillity is
          reasonably assured.

          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
          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:

          The Company has elected to follow Accounting Principle Board Opinion
          ("APB") No. 25, "Accounting for Stock Issued to Employees," and FASB
          Interpretation ("FIN") No. 44, "Accounting for Certain Transactions
          Involving Stock Compensation," in accounting for its employee stock
          option plans. Under APB No. 25, when the exercise price of the
          Company's share options is less than the market price of the
          underlying shares on the date of grant, compensation expense is
          recognized.

          The Company adopted the disclosure provisions of SFAS No. 148,
          "Accounting for Stock-Based Compensation - Transition and Disclosure",
          which amended certain provisions of SFAS No. 123, "Accounting for
          Stock-Based Compensation", to provide alternative methods of
          transition for an entity that voluntarily changes to the fair value
          based method of accounting for stock-based employee compensation,
          effective as of the beginning of the prior fiscal year. The Company
          continues to apply the provisions of APB No. 25 in accounting for
          stock-based compensation.

          Pro forma information regarding net income and net earnings per share
          is required by SFAS No. 123, and has been determined as if the Company
          had accounted for its employee stock options under the fair value
          method prescribed by SFAS No. 123.


                                     F - 16`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          The fair value for options granted in 2004 and 2005 is amortized over
          their vesting period and estimated at the grant date using the Black
          and Scholes option pricing model with 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

          Pro forma information under SFAS No. 123:

                                                                         YEAR ENDED DECEMBER 31,
                                                         ---------------------------------------------------
                                                             2003                 2004                2005
                                                         ------------         ------------         ---------

Net income (loss) as reported:                           $      2,404         $      1,053         $  (3,211)
Add: stock-based compensation expenses
   determined under the intrinsic value based
   method included in the reported net income                       3                  184               439
Deduct: stock-based compensation expenses
   determined under fair value based method for
   all awards                                                    (111)                (198)           (1,493)
                                                         ------------         ------------         ---------

Pro forma net income                                     $      2,296         $      1,039         $  (4,265)
                                                         ============         ============         =========

Basic net earnings (loss) per share, as reported         $       0.30         $       0.12         $   (0.32)
                                                         ============         ============         =========

Diluted net earnings (loss) per share, as
   reported                                              $       0.30         $       0.12         $   (0.32)
                                                         ============         ============         =========

Pro forma basic net earnings (loss) per share            $       0.29         $       0.12         $   (0.43)
                                                         ============         ============         =========

Pro forma diluted net earnings (loss) per share          $       0.29         $       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.


                                     F - 17`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     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 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 $ 128, $
          228 and $ 8 in 2003, 2004 and 2005, respectively.

     r.   Net earnings (loss) per share:

          Basic net earnings per share is computed based on the weighted average
          number of shares of Ordinary shares outstanding during each year.
          Diluted net earnings per share is computed based on the weighted
          average number of shares of Ordinary shares outstanding during each
          year, plus dilutive potential shares of 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, short-term and long-term bank deposits, structured notes,
          unbilled accounts receivable, trade receivables and long-term trade
          receivables.

          Cash and cash equivalents, short-term and long-term bank deposits and
          structured notes 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.


                                     F - 18`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          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 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. In
          certain circumstances, the Group may require letters of credit, other
          collateral or additional guarantees.

          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.

     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, 2003, 2004 and
          2005, amounted to approximately $ 313, $ 306 and $ 362, respectively.


                                     F - 19`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     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, 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,
               long-term bank deposits and structured notes 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,
               2004, the fair value of the Company's long-term borrowing was $
               5,318, compared to the carrying amount of $ 5,349. 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.

          (iv) The fair value of foreign currency contracts (used for hedge
               purposes) is estimated by obtaining current quotes from brokerage
               firms.

     w.   Advertising expenses:

          Advertising costs are expensed as incurred. Advertising expenses for
          the years ended December 31, 2003, 2004 and 2005, were $ 422, $ 495
          and $ 420, 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 2003, 2004 and 2005 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.


                                     F - 20`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          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.

          During 2005, the Company recognized no hedge ineffectiveness for the
          Euro contract cash flows hedge as the Company concluded that the
          changes in the cash flows attributable to the changes in the exchange
          rates are completely offset by the forward contract.

          The Company determined 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, the forward loss
          was recorded in financial expenses in 2005.

          As of December 31, 2005, the Company expects to reclassify $ 6 of net
          income on derivative instruments from other comprehensive income to
          earnings during the next 12 months due to actual sales and related
          payments.

     y.   Reclassification:

          An amount of $ 1,870 in billed accounts receivable was reclassified
          from unbilled accounts to trade receivables to conform to current year
          presentation. The reclassification had no effect on previously
          reported net income, shareholders' equity or cash flows.

          See also Note 16a.

     z.   Impact of recently issued accounting standards:

          On December 16, 2004, the FASB issued SFAS No. 123(R) (revised 2004),
          "Share-Based Payment," which is a revision of SFAS No. 123,
          "Accounting for Stock-Based Compensation" ("SFAS 123(R)"). Generally,
          the approach in SFAS 123(R) is similar to the approach described in
          SFAS No. 123. However, SFAS 123 permitted, but did not require,
          share-based payments to employees to be recognized based on their fair
          values while SFAS 123(R) requires all share-based payments to
          employees to be recognized based on their fair values. SFAS 123(R)
          also revises, clarifies and expands guidance in several areas,
          including measuring fair value, classifying an award as equity or as a
          liability and attributing compensation cost to reporting periods. The
          Company adopted SFAS 123(R) on January 1, 2006.


                                     F - 21`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          SFAS 123(R) permits companies to adopt its requirements using one of
          the following two methods:

          1.   The "modified prospective" method, in which compensation cost is
               recognized commencing with the effective date (i) based on the
               requirements of SFAS 123(R) for all share-based payments granted
               after the effective date and (ii) based on the requirements of
               SFAS 123 for all awards granted to employees prior to the
               effective date of SFAS 123(R) that remain unvested at the
               effective date.

          2.   The "modified retrospective" method, which includes the
               requirements of the modified prospective method described above,
               but also permits entities to restate based on the amounts
               previously recognized under SFAS 123, for purposes of pro forma
               disclosures all prior periods presented.

          As permitted by SFAS 123, the Company currently accounts for
          share-based payments to employees using APB 25, the intrinsic value
          method. The impact of the adoption of SFAS 123(R) cannot be predicted
          at this time, as it depends on levels of share-based payments for
          future grant. However, had the Company adopted SFAS 123(R) in prior
          periods, the impact of that Standard would have approximated the
          impact of SFAS 123, as described in the disclosure of the pro forma
          information above.

          In March 2005, the SEC Staff issued Staff Accounting Bulletin No. 107
          (SAB 107) to give guidance on implementation of SFAS 123(R).

NOTE 3:- INVENTORIES

                                         DECEMBER 31,
                                    -----------------------
                                      2004            2005
                                    -------         -------

          Raw materials             $ 6,806         $ 4,902
          Work in progress            2,320           1,855
          Finished products           3,576           4,353
                                    -------         -------

                                    $12,702         $11,110
                                    =======         =======


                                     F - 22`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 4:- PROPERTY AND EQUIPMENT

     a.   Composition:

                                                                  DECEMBER 31,
                                                             -----------------------
                                                              2004             2005
                                                             -------         -------
Cost:
   Land and buildings                                        $ 8,790         $ 8,949
   Machinery and equipment                                     4,411           5,401
   Machinery and equipment leased to customers under
     operating leases                                          4,952           6,796
   Motor vehicles                                              1,341           1,297
   Promotional display                                         4,236           4,115
   Office furniture and equipment                              2,924           3,190
   Leasehold improvements                                        784             780
                                                             -------         -------

                                                              27,438          30,528
                                                             -------         -------
Accumulated depreciation:
   Buildings                                                   2,404           2,698
   Machinery and equipment                                     2,958           3,846
   Machinery and equipment leased to customers under
     operating leases                                            845           1,342
   Motor vehicles                                                833             941
   Promotional display                                         3,322           3,433
   Office furniture and equipment                              2,356           2,554
   Leasehold improvements                                         61             127
                                                             -------         -------

                                                              12,779          14,941
                                                             -------         -------

Depreciated cost                                             $14,659         $15,587
                                                             =======         =======


     b.   Depreciation expenses amounted to $ 1,241, $ 1,822 and $ 1,823 for the
          years ended December 31, 2003, 2004 and 2005, respectively.

     c.   As for charges, see Note 9g.


                                     F - 23`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 5:- OTHER INTANGIBLE ASSETS, NET

     a.   Composition:

                                       DECEMBER 31,
                                  ---------------------
                                   2004           2005
                                  ------         ------
Cost:
   Know-how                       $  502         $  502
   Patents                         2,639          2,787
   Technology                        436            436
                                  ------         ------

                                   3,577          3,725
                                  ------         ------
Accumulated amortization:
   Know-how                          396            446
   Patents                         2,443          2,575
   Technology                         82            135
                                  ------         ------

                                   2,921          3,156
                                  ------         ------

Amortized cost                    $  656         $  569
                                  ======         ======

     b.   Amortization expenses related to intangible assets amounted to $ 137,
          $ 144 and $ 141 for the years ended December 31, 2003, 2004 and 2005,
          respectively.

     c.   Estimated amortization of intangible assets for the years ended:

          DECEMBER 31,
          ------------

          2006            $111
          2007             102
          2008              93
          2009              86
          2010             177
                          ----

                          $569
                          ====

                                     F - 24`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 6:- SHORT-TERM BANK CREDIT

     a.   Classified by currency, linkage terms and interest rates:

                                                   INTEREST RATE           DECEMBER 31,
                                                 -----------------    -----------------------
                                                 2004         2005      2004           2005
                                                 ----         ----    -------         -------
                                                         %
                                                 -----------------

In or linked to U.S. dollars (1)                 4.08         4.14    $ 8,600         $15,100
In or linked to NIS (1)                          5.47         5.00      5,556           1,742
In or linked to Canadian
   dollars (2)                                   4.75            -      1,462               -
In or linked to PLN (1)                             -         5.92          -           1,226
                                                                      -------         -------

                                                                      $15,618         $18,068
                                                                      =======         =======

Weighted average interest                        4.64         4.62
   rates at the end of the year

Total authorized credit lines
   approximate                                                        $33,245         $48,895
                                                                      =======         =======

Unutilized credit lines
   approximate                                                        $ 6,352         $15,781
                                                                      =======         =======

          (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, 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. One
               of the banks has agreed to waive such requirement for 2005 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. Although the Company has not received a
               formal waiver from the other bank to date, management believes
               that such waiver will be obtained within the next few weeks. As
               of December 31, 2005, the balance due to the abovementioned bank,
               amounts to approximately $ 2,370 in short-term bank credit.

          (2)  The loan to a subsidiary is collateralized by a general security
               agreement. The subsidiary has undertaken to maintain general
               covenants and the following financial ratios, with respect to the
               subsidiary's financial statements, and terms in respect of its
               used credit lines: (i) a quick ratio of not less than 1.25, (ii)
               a ratio of total liabilities to tangible net worth of not greater
               than 0.75 and (iii) tangible net worth of at least $ 9,000.

               As of December 31, 2005, the subsidiary has no commitments to the
               bank.

     b.   As for charges, see Note 9g.

                                     F - 25`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

                                                                               DECEMBER 31,
                                                                          ---------------------
                                                                           2004           2005
                                                                          ------         ------

Employees and payroll accruals                                            $1,380         $1,596
Provision in respect of demand for bank performance guarantee (1)              -          1,436
Accrued expenses                                                           3,911          4,599
Deferred revenues                                                             81            284
Government authorities                                                       308             84
Income tax payable                                                             3            249
Others                                                                       986            666
                                                                          ------         ------

                                                                          $6,669         $8,914
                                                                          ======         ======

     (1)  See also Note 17.

NOTE 8:- LONG-TERM BANK DEBT

     a.   Classified by currency, linkage terms and interest rates:

                                                       INTEREST RATE                   DECEMBER 31,
                                       LINKAGE       ------------------            --------------------
                                        TERMS        2004          2005            2004            2005
                                        -----        ----          ----            ----            ----
                                                             %
                                                     ------------------

Bank loan                               U.S. $          3.10          3.10         $2,500         $2,500
Bank promissory note                    U.S. $             -          5.45              -            820
Bank promissory note                    U.S. $             -          5.45              -            980
Bank promissory note (1)                U.S. $          3.05         5.175            500            500

Bank promissory note (1)                U.S. $          3.50         5.625            500            500
                                                                                   ------         ------

                                                                                    3,500          5,300


Mortgage payable                        U.S. $          8.25             -          1,849              -
                                                                                   ------         ------

                                                                                    5,349          5,300
Less - current
   maturities                                                                       1,849          3,647
                                                                                   ------         ------

                                                                                   $3,500         $1,653
                                                                                   ======         ======
Weighted average
   interest rates at
   the end of the
   year                                                 4.91          4.33


                                     F - 26`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 8:- LONG-TERM BANK DEBT (CONT.)

          (1)  As for financial ratios and terms in respect of long-term loans,
               the two $ 500 promissory notes both have covenants that require
               the Group to maintain $ 1 thousand 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, 2005, management believes that the Group was
               in compliance with these ratios and terms.

     b.   As of December 31, 2005, the aggregate annual maturities of the
          long-term loans are as follows:

          2006                            $  3,647
          2007                                 155
          2008                                 163
          2009                                 173
          2010                               1,162
                                          --------

                                          $  5,300
                                          ========

     c.   As for charges, see Note 9g.

NOTE 9:- 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 $ 80, $ 61 and $ 83 for the years ended
          December 31, 2003, 2004 and 2005, respectively. As of December 31,
          2005, the Company had remaining contingent obligations to pay
          royalties in the amount of approximately $ 1,792.


                                     F - 27`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

     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, 2003, 2004
          and 2005. As of December 31, 2005, 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,
          2005, royalty commitments under the agreement amounted to $ 17.

     d.   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 2009.

          Future minimum lease payments under non-cancelable operating lease
          agreements as of December 31, are as follows:

          2006                   $  404
          2007                      243
          2008                      137
          2009                       37
                                -------

                                $   821
                                =======

          Total rent expenses for the years ended December 31, 2003, 2004 and
          2005, were approximately $ 368, $ 671 and $ 593, respectively.

                                     F - 28`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

     e.   Guarantees:

          As of December 31, 2005, the Group obtained bank performance
          guarantees and advance payment guarantees and bid bond guarantees from
          several banks mainly in Israel in the amount of $ 8,670. As for a
          customer's demand for the payment under a bank performance guarantee,
          see Note 17.

     f.   Legal proceedings:

          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. The Company's legal counsel believes that the Company has
          valid defenses against the aforementioned claims and, therefore, no
          provision was recorded in the financial statements.

          For arbitration procedures against Company's customer, see Note 17.

     g.   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 April 15, 2006, 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 10:- SHAREHOLDERS' EQUITY

     a.   Pertinent rights and privileges conferred by Ordinary shares:

          The Ordinary shares of the Company are listed for trade on NASDAQ
          National 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, 2005, there were 299,676 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 10:- SHAREHOLDERS' EQUITY (CONT.)

          A summary of the Company's stock options activities in 2003, 2004 and
          2005, is as follows:

                                                             YEAR ENDED DECEMBER 31,
                            ---------------------------------------------------------------------------------------
                                       2003                           2004                           2005
                            -----------------------         -----------------------         -----------------------
                                             WEIGHTED                        WEIGHTED                     WEIGHTED
                            NUMBER           AVERAGE         NUMBER          AVERAGE       NUMBER          AVERAGE
                              OF             EXERCISE          OF           EXERCISE         OF            EXERCISE
                            OPTIONS           PRICE         OPTIONS           PRICE        OPTIONS          PRICE
                            --------          -----         --------          -----         -------         -----

Outstanding at the
   beginning of the
   year                      358,234          $4.23          223,216          $4.61         105,000         $7.66
Granted                            -          $   -          100,000          $7.66         238,000         $8.65
Adjustment as a
   result of stock
   dividend                   10,256          $   -            7,652          $   -               -         $   -
Exercised                   (137,446)         $3.55         (225,338)         $4.61               -         $   -
Forfeited                     (7,828)         $   -             (530)         $   -               -         $   -
                            --------                        --------                        -------

Outstanding at the
   end of the year           223,216          $4.61          105,000          $7.66         343,000         $8.35
                            ========          =====         ========          =====         =======         =====

Exercisable options
   at the end of
   the year                  223,216          $4.61                -          $   -         231,200         $8.56
                            ========          =====         ========          =====         =======         =====

          The options outstanding as of December 31, 2005 have been separated
          into ranges of exercise price as follows:


                                                                           OPTIONS
           OPTIONS                                                      EXERCISABLE AS
         OUTSTANDING                             WEIGHTED AVERAGE             OF
            AS OF                                   REMAINING            DECEMBER 31,
      DECEMBER 31, 2005     EXERCISE PRICE        CONTRACTUAL LIFE           2005
    --------------------   -----------------    -------------------    -----------------
                                                   (IN MONTHS)

          105,000                $ 7.66                 1                        -
          233,000                $ 8.56                 -                  231,200
            5,000                $13                   24                        -
        ---------                                                          -------

          343,000                $ 8.35                                    231,200
        =========                ======                                    =======

          Where the Company has recorded deferred stock compensation for options
          issued with an exercise price below the fair market value of the
          Ordinary shares, the deferred stock compensation has been amortized
          and recorded as compensation expense ratably over the vesting period
          of the options. Compensation expenses of approximately $ 3, $ 184 and
          $ 439 were recognized during the years ended December 31, 2003, 2004
          and 2005, respectively.


                                     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 10:- SHAREHOLDERS' EQUITY (CONT.)

     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 dividend.

          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.

NOTE 11:- BASIC AND DILUTED NET EARNINGS PER SHARE

                                                                               YEAR ENDED DECEMBER 31,
                                                                --------------------------------------------------------
                                                                   2003                 2004                   2005
                                                                ----------         -------------          -------------
Numerator:

Income (loss) from continuing operations                        $    2,390         $       1,174          $      (3,055)
Gain (loss) on discontinued operations                                  14                  (121)                  (156)
                                                                ----------         -------------          -------------

Net income (loss)                                               $    2,404         $       1,053          $      (3,211)
                                                                ==========         =============          =============

Denominator:

Denominator for basic net earnings per share -
   weighted-average number of shares outstanding                 7,947,778             8,581,348              9,883,407
Effect of diluting securities:
Employee stock options and warrants to underwriters                 80,848                55,031                 16,926
                                                                ----------         -------------          -------------

Denominator for diluted net earnings per share -
   adjusted weighted average shares and assumed
   exercises                                                     8,028,626             8,636,379              9,900,333
                                                                ==========         =============          =============

Basic net earnings (loss) per share from continuing
   operations                                                   $     0.30         $        0.13          $       (0.31)
Basic net loss per share from discontinued operations                    -                 (0.01)                 (0.01)
                                                                ----------         -------------          -------------

Basic net earnings (loss) per share                             $     0.30         $        0.12          $       (0.32)
                                                                ==========         =============          =============

Diluted net earnings (loss) per share form continuing
   operations                                                   $     0.30         $        0.13          $       (0.31)
Diluted net loss per share from discontinued operations                  -                 (0.01)                 (0.01)
                                                                ----------         -------------          -------------

Diluted net earnings (loss) per share                           $     0.30         $        0.12          $       (0.32)
                                                                ==========         =============          =============


                                     F - 32`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 12:- TAXES ON INCOME

     a.   Tax benefits in Israel under the Law for the Encouragement of Capital
          Investments, 1959 ("the Law"):

          The Company has been granted the status of an "Approved Enterprise"
          under the Law. Currently, there are three expansion programs under
          which the Company is entitled to tax benefits:

          1.   In 1992, a program of the Company was granted the status of an
               "Approved Enterprise". The Company has elected to enjoy 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 was
               subject to a reduced tax rate of 15%-25% for a period ranging
               between three to six years (depending on the percentage of
               foreign ownership of the Company). The period of benefits under
               this program began in 1994 and terminated in 2003.

          2.   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.

          3.   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, 2005, management believes that
          the Company is in compliance with all of the aforementioned
          conditions.


                                     F - 33`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 12:- TAXES ON INCOME (CONT.)

          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.

          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.

          Income from sources other than "Approved Enterprise", during the
          benefit period will be subject to tax at regular rate of 34% in 2005
          (see d. 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 34%), 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.


                                     F - 34`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 12:- TAXES ON INCOME (CONT.)

          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%).

     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.   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%.

               The amendment had no material impact on the Company's financial
               statements.

          2.   The tax rates of the Company's subsidiaries range between
               25%-40%.

     e.   Investment tax credit:

          One of the Company's subsidiaries is eligible for investment tax
          credits on its research and development activities and on certain
          current and capital expenditures. During fiscal year 2005, the
          subsidiary recognized $ 153 of investment tax credits as a reduction
          of research and development expenses. In total, the subsidiary has
          investment tax credits available to reduce future federal income taxes
          payable, amounting to $ 249, which will expire at various dates from
          2014 through 2015.


                                     F - 35`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)

NOTE 12:- TAXES ON INCOME (CONT.)

     f.   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,
                                                         -------------------------------------------
                                                           2003             2004              2005
                                                         -------           -------           -------

Income (loss) before taxes as reported in the            $ 3,300           $ 2,307           $(3,078)
   statements of income
                                                         =======           =======           =======

Tax rate                                                      36%               35%               34%
                                                         =======           =======           =======

Theoretical tax expense (tax benefit)                    $ 1,188           $   807           $(1,047)

Increase (decrease) in taxes:
   Non-deductible items, net                                  17              (400)               25
   Deferred taxes on losses for which valuation
     allowance was provided                                  298             1,163               579
   Tax exemption applicable to "Approved
     Enterprises" and exempted income                       (440)             (302)              347
   Taxes in respect of prior years                          (107)              (23)               52
   Other                                                     (46)             (112)               21
                                                         -------           -------           -------

Taxes on income (tax benefit) in the statements
   of income                                             $   910           $ 1,133           $   (23)
                                                         =======           =======           =======

Per share amounts (basic and diluted) of the tax
   benefit resulting from "Approved Enterprises"         $  0.06           $  0.03           $ (0.04)
                                                         =======           =======           =======

     g.   Taxes on income included in the statements of income:

Current taxes:
   Domestic                                              $   395           $   460           $     -
   Foreign                                                   534               518               620

Deferred income taxes (tax benefit):
   Domestic                                                    -               (70)             (642)
   Foreign                                                    88               248               (53)

Taxes in respect of prior years:
   Domestic                                                 (107)                -                 -
   Foreign                                                     -               (23)               52
                                                         -------           -------           -------

Taxes on income (tax benefit) from continuing
   operations                                                910             1,133               (23)
Taxes on income (tax benefit) from discontinued
   operations                                                  3               (32)              (37)
                                                         -------           -------           -------

Total taxes on income                                    $   913           $ 1,101           $    14
                                                         =======           =======           =======


                                     F - 36`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 12:- TAXES ON INCOME (CONT.)

     h.   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 deferred tax assets are
          as follows:

                                                               DECEMBER 31,
                                                         ------------------------
                                                          2004             2005
                                                         -------          -------

Operating loss carryforward                              $ 2,992          $ 3,923
Reserves and tax allowances                                  (26)             963
                                                         -------          -------

Total deferred assets before valuation allowance           2,966            4,886
Valuation allowance                                       (2,292)          (2,871)
                                                         -------          -------

Net deferred tax assets                                  $   674          $ 2,015
                                                         =======          =======

Domestic                                                 $   288          $ 1,553
Foreign                                                      386              462
                                                         -------          -------

                                                         $   674          $ 2,015
                                                         =======          =======

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


                        YEAR ENDED DECEMBER 31,
                 ---------------------------------------
                  2003           2004             2005
                 ------         -------          -------

Domestic         $2,200         $ 2,290          $(2,998)
Foreign           1,100              17              (80)
                 ------         -------          -------

                 $3,300         $ 2,307          $(3,078)
                 ======         =======          =======

     j.   Net operating losses carryforward:

          The Company has estimated total available carryforward tax losses of $
          2,377 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 $ 8,331 and $ 944,
          respectively, to offset against future taxable income for 16 to 20
          years, and an indefinite period, respectively. As of December 31,
          2005, 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

NOTE 13:- BALANCES AND TRANSACTIONS WITH RELATED PARTIES

     a.   Balances with related parties:

                                        DECEMBER 31,
                                     -----------------
                                     2004         2005
                                     ----         ----

Balances with related parties        $ 35         $290
                                     ====         ====

     b.   Sales to related parties:

                                         YEAR ENDED DECEMBER 31,
                                     ------------------------------
                                     2003         2004         2005
                                     ----         ----         ----

Sales to related parties (1)         $196         $386         $671
                                     ====         ====         ====


          (1)  Sales to related parties represent services provided by the
               Company's subsidiary.

NOTE 14:- 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 is executing turnkey projects
          based on the Company's security management system and acting as an
          integrator.

     3.   Video monitoring services - The Group supplies video monitoring
          services through Smart Interactive Systems, Inc., a subsidiary
          established in the U.S. in June 2001.



                                     F - 38`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 14:- 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,
                        --------------------------------------------------------------------------------------------------------------------------------------------------------
                                              2003                                               2004                                               2005
                        ------------------------------------------------  ---------------------------------------------------  -------------------------------------------------
                                                VIDEO                                           VIDEO                                               VIDEO
                        PERIMETER  PROJECTS MONITORING  OTHER    TOTAL   PERIMETER  PROJECTS  MONITORING    OTHER     TOTAL   PERIMETER  PROJECTS MONITORING OTHER      TOTAL
                         --------   -------  -------   -------  --------  --------   -------   -------     -------   --------  --------   -------  -------  --------   --------

Revenues                 $ 51,077   $ 6,720  $   403   $   455  $ 58,655  $ 46,342   $11,375   $ 2,060     $   691   $ 60,468  $ 40,143   $17,970  $ 2,897  $    272   $ 61,282
                         ========   =======  =======   =======  ========  ========   =======   =======     =======   ========  ========   =======  =======  ========   ========

Depreciation and
   amortization          $  1,056   $    20  $   292   $    10  $  1,378  $  1,252   $    11   $   698     $     5   $  1,966  $  1,228   $    19  $   713  $      4   $  1,964
                         ========   =======  =======   =======  ========  ========   =======   =======     =======   ========  ========   =======  =======  ========   ========

Operating income
   (loss),
   before
   financial
   expenses and
   taxes on income       $  5,803   $   936  $(1,870)  $  (566) $  4,303  $  4,978   $ 1,430   $(2,262)    $(1,077)  $  3,069  $  4,334   $(5,290) $(1,375) $     53   $ (2,278)
                         ========   =======  =======   =======            ========   =======   =======     =======             ========   =======  =======  ========
Financial
   expenses, net                                                  (1,003)                                                (762)                                             (800)
Taxes on income                                                      910                                                1,133                                                23
Gain (loss) on
   discontinued
   operations, net                                                    14                                                 (121)                                             (156)
                                                                --------                                             --------                                          --------

Net income                                                      $  2,404                                             $  1,053                                          $ (3,211)
                                                                ========                                             ========                                          ========

                                                                                              DECEMBER 31,
                        --------------------------------------------------------------------------------------------------------------------------------------------------------
                                              2003                                               2004                                               2005
                        ------------------------------------------------  ---------------------------------------------------  -------------------------------------------------
                                                VIDEO                                           VIDEO                                               VIDEO
                        PERIMETER  PROJECTS MONITORING  OTHER    TOTAL   PERIMETER  PROJECTS  MONITORING    OTHER     TOTAL   PERIMETER  PROJECTS MONITORING OTHER      TOTAL
                         --------   -------  -------   -------  --------  --------   -------   -------     -------   --------  --------   -------  -------  --------   --------

Total long-lived
   assets                 $13,476     $88     $2,787     $12     $16,363   $13,576    $192     $5,814        $19     $19,601   $13,042     $194     $7,087     $19     $20,342
                          =======     ===     ======     ===     =======   =======    ====     ======        ===     =======   =======     ====     ======     ===     =======


                                     F - 39`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 14:- SEGMENT INFORMATION (CONT.)

     b.   Major customer data (percentage of total revenues):

                   YEAR ENDED DECEMBER 31,
                 ---------------------------
                 2003       2004        2005
                 ----       ----        ----

Customer A       27.5%      *) -        23.9%
                 ====       ====        ====
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,
                                    -----------------------------------
                                     2003          2004          2005
                                    -------       -------       -------
1. Revenues:

   Israel                           $19,797       $ 9,617       $19,309
   Romania                            5,151         9,521         6,244
   Europe (excluding Romania)         5,465         9,150         3,691
   USA                               13,292        17,871        13,185
   Canada                             6,338         4,068         8,759
   Others                             8,612        10,241        10,094
                                    -------       -------       -------

                                    $58,655       $60,468       $61,282
                                    =======       =======       =======
2. Long-lived assets:

   Israel                           $ 3,626       $ 3,211       $ 2,930
   Europe                               980         1,069           921
   USA                                8,655        11,518        12,714
   Canada                             2,998         3,649         3,656
   Others                               104           154           121
                                    -------       -------       -------

                                    $16,363       $19,601       $20,342
                                    =======       =======       =======


                                     F - 40`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 15:- SELECTED STATEMENTS OF INCOME DATA

     a.   Research and development expenses, net:

                                                                    YEAR ENDED DECEMBER 31,
                                                             -------------------------------------
                                                              2003            2004          2005
                                                             -------        -------        -------

          Expenses                                           $ 5,128        $ 5,088        $ 5,427
          Less - royalty-bearing grants and investment
             tax credit                                          355            405            162
                                                             -------        -------        -------

                                                             $ 4,773        $ 4,683        $ 5,265
                                                             =======        =======        =======

     b.   Financial income (expenses):

          Financial expenses:
             Interest on long-term debt                      $  (298)       $  (289)       $  (622)
             Interest on short-term bank credit                 (808)          (849)          (630)
             Forward contracts loss                                -              -           (110)
             Foreign exchange losses                            (692)          (161)          (314)
                                                             -------        -------        -------

                                                              (1,798)        (1,299)        (1,676)
                                                             -------        -------        -------
          Financial income:
             Interest on short-term and long-term bank
               deposits and structured notes                     672            496            707
             Foreign exchange gains                              123             41            169
                                                             -------        -------        -------

                                                                 795            537            876
                                                             -------        -------        -------

                                                             $(1,003)       $  (762)       $  (800)
                                                             =======        =======        =======

NOTE 16:- 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 income
          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

NOTE 16:- DISCONTINUED OPERATIONS (CONT.)

     b.   The following are the results of discontinued operations for the years
          ended December 31, 2003, 2004 and 2005:

                                        YEAR ENDED DECEMBER 31,
                                    -----------------------------
                                    2003        2004         2005
                                    ----       -----        -----

Revenues                            $706       $ 506        $ 427
Cost of revenues                     531         499          470
                                    ----       -----        -----

Gross profit (loss)                  175           7          (43)
                                    ----       -----        -----

Operating expenses:

Sales and marketing, net             158         160          149
                                    ----       -----        -----

Operating income (loss)               17        (153)        (192)

Taxes on income (tax benefit)          3         (32)         (36)
                                    ----       -----        -----

Net income (loss)                   $ 14       $(121)       $(156)
                                    ====       =====        =====

NOTE 17:- SUBSEQUENT EVENT

     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. 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 $
     3,181 related to an advance payment that was secured by a bank advance
     payment guarantee on June 20, 2006.


                                     F - 42`

`MAGAL SECURITY SYSTEMS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 17:- SUBSEQUENT EVENT (CONT.)

     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 has not yet filed its response.
     Based on the opinion of the Company's legal counsel, the Company believes
     that there is a good likelihood that the arbitration will result in a
     favorable decision for the Company.

     Due to 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. Although the Company obtained the temporary
     injunction, according to its legal counsel, the Company's chances to
     ultimately prevent the forfeiture of the guarantee remain unclear. In view
     of the above, and due to the uncertainty in preventing the forfeiture of
     the guarantee, the Company included a provision in the amount of $ 1,436 in
     respect of this guarantee in its financial statements.


                                     F - 43`

`SIGNATURE

     The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.


                                                MAGAL SECURITY SYSTEMS LTD.

                                                By: /s/ Jacob Even-Ezra
                                                -----------------------
                                                Jacob Even-Ezra
                                                Chairman of the Board and
                                                Chief Executive Officer
                                                Date: July 14, 2006


                                       86`