---

---

# SECURITIES AND
EXCHANGE COMMISSIONWashington D.C. 20549

# FORM 20-F

|o | REGISTRATION
STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------------

# OR

|x | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year
ended December 31, 2008
|- | --------------------------------------------------------------------------------------------------------------------------------

# OR

|o | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

|For
the transition period from __________ to __________
|-------------------------------------------------------

|o | SHELL
COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934Date 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)

+972-3-5391444 (phone), +972-3-5366245 (fax)
P.O. Box 70, Industrial Zone, Yehud 56100, Israel(Name, Telephone, E-mail and/or Facsimile number of Company Contact Person)

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

|                                   |                                          
|---------------------------------- | -----------------------------------------
|
|
|
|
|Title of each class                | Name of each exchange on which registered
|Ordinary Shares, NIS 0.1 Par Value | NASDAQ Global Market                     
|                                   |                                          

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

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

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

Ordinary Shares, par value NIS 1.0 per share..........10,396,548(as of December 31, 2008)

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

Yes o No x

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

Yes o No x



---

---

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

Yes x No o

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

|                          |                     |                        
|------------------------- | ------------------- | -----------------------
|
|
|
|
|Large accelerated filer o | Accelerated filer x | Non-accelerated filer o
|                          |                     |                        

Indicate by check mark which basis of
accounting the registrant has used to prepare the financial statements included in this
filing:

|            |  |                         |        
|----------- |  | ----------------------- | -------
|
|
|
|
|U.S. GAAP x |  | International Financial | Other o

| | Reporting Standards as issued
by the International Accounting
Standards Board o
| | -------------------------------------------------------------------------------

If Other has been checked
in response to the previous question, indicate by check mark which financial statement
item the registrant has elected to follow:

Item 17 o Item 18 o

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 o No x

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



---

---

# 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                                            | 3       
|ITEM 4.  | Information on the Company                                    | 12      
|         | A.    History and Development of the Company                  | 12      
|         | B.    Business Overview                                       | 13      
|         | C.    Organizational Structure                                | 23      
|         | D.    Property, Plants and Equipment                          | 24      
|ITEM 4A. | Unresolved Staff Comments                                     | 24      
|ITEM 5.  | Operating and Financial Review and Prospects                  | 24      
|         | A.    Operating Results                                       | 25      
|         | B.    Liquidity and Capital Resources                         | 41      
|         | C.    Research and Development, Patents and Licenses          | 44      
|         | D.    Trend Information                                       | 44      
|         | E.    Off-Balance Sheet Arrangements                          | 45      
|         | F.    Tabular Disclosure of Contractual Obligations           | 45      
|ITEM 6.  | Directors, Senior Management and Employees                    | 46      
|         | A.    Directors and Senior Management                         | 46      
|         | B.    Compensation                                            | 48      
|         | C.    Board Practices                                         | 49      
|         | D.    Employees                                               | 55      
|         | E.    Share Ownership                                         | 56      
|ITEM 7.  | Major Shareholders and Related Party Transactions             | 57      
|         | A.    Major Shareholders                                      | 57      
|         | B.    Related Party Transactions                              | 59      
|         | C.    Interests of Experts and Counsel                        | 61      
|ITEM 8.  | Financial Information                                         | 61      
|         | A.    Consolidated Statements and Other Financial Information | 61      
|         | B.    Significant Changes                                     | 62      
|ITEM 9.  | The Offer and Listing                                         | 62      
|         | A.    Offer and Listing Details                               | 62      
|         | 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                  | 64      
|         | C.    Material Contracts                                      | 67      
|         | D.    Exchange Controls                                       | 67      
|         | E.    Taxation                                                | 67      
|         | F.    Dividends and Paying Agents                             | 78      
|         | G.    Statements by Experts                                   | 78      
|         | H.    Documents on Display                                    | 78      
|         | I.     Subsidiary Information                                 | 79      
|ITEM 11. | Quantitative and Qualitative Disclosures about Market Risk    | 79      
|ITEM 12. | Description of Securities Other Than Equity Securities        | 80      

i

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---

|          |                                                                              | Page No.
|--------- | ---------------------------------------------------------------------------- | --------
|
|
|
|
|PART II   |                                                                              | 80      
|ITEM 13.  | Defaults, Dividend Arrearages and Delinquencies                              | 80      
|ITEM 14.  | Material Modifications to the Rights of Security Holders and Use of Proceeds | 80      
|ITEM 15.  | Controls and Procedures                                                      | 80      
|ITEM 16A. | Audit Committee Financial Expert                                             | 82      
|ITEM 16B. | Code of Ethics                                                               | 82      
|ITEM 16C. | Principal Accountant Fees and Services                                       | 82      
|ITEM 16D. | Exemptions from the Listing Standards for Audit Committees                   | 83      
|ITEM 16E. | Purchase of Equity Securities by the Issuer and Affiliated Purchasers        | 83      
|ITEM 16F. | Changes In Registrant's Certifying Accountant                                | 83      
|ITEM 16G. | Corporate Governance                                                         | 83      
|PART III  |                                                                              | 83      
|ITEM 17.  | Financial Statements                                                         | 83      
|ITEM 18.  | Financial Statements                                                         | 83      
|ITEM 19.  | Exhibits                                                                     | 84      
|SIGNATURE |                                                                              | 87      

ii

---

---

# INTRODUCTION

Magal
Security Systems Ltd. is a leading international solutions provider of safety, security,
site management and intelligence gathering and compilation. Based on 35 years of
experience and interaction with customers, we have developed a unique set of solutions and
products, optimized for perimeter, outdoor and general security applications. Our turnkey
solutions are typically integrated and managed by sophisticated modular command and
control software, supported by expert systems for real-time decision support. Our
portfolio of critical infrastructure protection and site protection technologies includes
a variety of smart barriers and fences, fence mounted detectors, virtual gates, buried and
concealed detection systems and a sophisticated protection package for sub-surface
intrusion. A world innovator in the development of closed circuit television, or CCTV,
intelligence video analysis and motion detection technology for outdoor operation, we have
successfully installed customized solutions and products in more than 75 countries
worldwide. Our ordinary shares are traded on the NASDAQ Global Market and on the Tel Aviv
Stock Exchange under the symbol MAGS. Our address on the Internet is
www.magal-ssl.com. The information on our website is not incorporated by reference
into this annual report. As used in this annual report, the terms we,
us and our mean Magal Security Systems Ltd. and its subsidiaries,
unless otherwise indicated.

We
have trademark rights in the United States and other national jurisdictions arising out of
our trademark registrations, applications, and/or use of the following trademarks and
service marks: SENSTAR-STELLAR logo, the S logos, SENSTAR-STELLAR, SENSTAR-STELLAR (and
design) SENSTAR, STELLAR, STELLAR SYSTEMS, STELLAR SYSTEMS (and design), PANTHER, GUIDAR,
REPELS, SENNET, PERIMITRAX, INTELLI-FLEX, INTELLI-FIELD, X-FIELD, OMNITRAX, STARLED,
STARNET, FRONTLINE, E-FIELD, H-FIELD, E-FLEX, ARMOURFLEX, SIMPL, CROSSFIRE, ECHOCHECK,
FLASH, FLARE, SENTRAX, OMNITRAX, XFIELD, DTR, DreamBox, Magal logo 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
consolidated financial statements appearing in this annual report are prepared in U.S.
dollars and in accordance with generally accepted accounting principles in the United
States, or U.S. GAAP. All references in this annual report to dollars or
$are to U.S. dollars and all references in this annual report to
NIS are to New Israeli Shekels. The representative exchange rate between the
NIS and the dollar as published by the Bank of Israel on June 30, 2009 was NIS 3.919 per
$1.00.

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.

This
Annual Report on Form 20-F contains various forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Exchange Act of 1934, as amended, and within the Private Securities
Litigation Reform Act of 1995, as amended. Such forward-looking statements reflect our
current view with respect to future events and financial results. Forward-looking
statements usually include the verbs, anticipates, believes,
estimates, expects, intends, plans,
projects, understands and other verbs suggesting uncertainty. We
remind readers that forward-looking statements are merely predictions and therefore
inherently subject to uncertainties and other factors and involve known and unknown risks
that could cause the actual results, performance, levels of activity, or our achievements,
or industry results, to be materially different from any future results, performance,
levels of activity, or our achievements expressed or implied by such forward-looking
statements. Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation to publicly
release any revisions to these forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of unanticipated events.
We have attempted to identify additional significant uncertainties and other factors
affecting forward-looking statements in the Risk Factors section which appears in Item 3.D
Key Information -Risk Factors.



---

---

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

The
following selected consolidated financial data for and as of the five years ended December
31, 2008 are derived from our audited consolidated financial statements which have been
prepared in accordance with U.S. GAAP. We have derived the following selected consolidated
financial data as of December 31, 2006 and 2007 and for each of the years ended
December 31, 2006, 2007 and 2008 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,
2004, 2005 and 2006 and for each of the years ended December 31, 2004 and 2005 from
our audited consolidated financial statements not included in this annual report. The
selected consolidated financial data set forth below should be read in conjunction with
and are qualified by reference to Item 5 Operating and Financial Review and
Prospects and our audited consolidated financial statements and notes thereto
included elsewhere in this annual report.

|                                            | Year Ended December 31,
|------------------------------------------- | -----------------------
|
|
|
|
|Consolidated Statement of Operations Data:  |                        
|Revenues                                    |                        
|Cost of revenues                            |                        
|                                            |                        
|Gross profit                                |                        
|                                            |                        
|Operating expenses:                         |                        
|Research and development, net               |                        
|Selling and marketing, net                  |                        
|General and administrative                  |                        
|Impairment of goodwill and other            |                        
|intangible assets                           |                        
|Post employment and termination             |                        
|benefits                                    |                        
|Award granted by principal shareholders     |                        
|                                            |                        
|Total operating expenses                    |                        
|                                            |                        
|Operating income (loss)                     |                        
|Financial expenses, net                     |                        
|                                            |                        
|Income (loss) before income taxes           |                        
|Income taxes (tax benefit)                  |                        
|                                            |                        
|Income (loss) from continuing operations    |                        
|Income (loss) from discontinued operations, |                        
|net                                         |                        
|                                            |                        
|Net income (loss)                           |                        
|                                            |                        
|Basic net earnings (loss) per share from    |                        
|continuing operations                       |                        
|Basic net earnings (loss)per share from     |                        
|discontinued operations                     |                        
|                                            |                        
|Basic net earnings (loss) per share         |                        
|                                            |                        
|Diluted net earnings (loss) per share from  |                        
|continuing operations                       |                        
|Diluted net earnings (loss)per share from   |                        
|discontinued operations                     |                        
|                                            |                        
|Diluted net earnings (loss) per share       |                        
|                                            |                        
|Weighted average number of ordinary shares  |                        
|used in computing basic net earnings per    |                        
|share                                       |                        
|Weighted average number of ordinary shares  |                        
|used in computing diluted net earnings per  |                        
|share                                       |                        
|                                            |                        

---

|(1) | In
July 2004, our board of directors declared a share dividend distribution of
                    5.0%, which was paid to our shareholders in August 2004 as a final
dividend for                     2003. Per share data for 2004 in the above table has
been adjusted to reflect                     the share dividend.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

1

---

---

|                                               | As of December 31,
|---------------------------------------------- | ------------------
|
|
|
|
|Consolidated Balance Sheets Data:              |                   
|Cash and cash equivalents                      |                   
|Short and long-term bank deposits,  restricted |                   
|deposits, marketable securities and escrow     |                   
|deposit                                        |                   
|Working capital                                |                   
|Total assets                                   |                   
|Short-term bank credit (including current      |                   
|maturities of long-term loans)                 |                   
|Long-term bank loans                           |                   
|Total shareholders' equity                     |                   
|                                               |                   

---

|(*) | Effective
as of September 1, 2007, our consolidated financial statements include
                    those of the European integration company that we acquired in
September 2007. In                     December 2007, we disposed of our U.S. based video
monitoring business.                     Accordingly, the operating results, balance
sheet and cash flows relating to the                     video monitoring operations were
presented in our statements of income, balance                     sheets and cash flows
as discontinued operations, and the comparative figures                     were
reclassified for all periods presented.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|B. | Capitalization
and Indebtedness.
|-- | --------------------------------

Not
applicable

|C. | Reasons
for the Offer and Use of Proceeds.
|-- | ------------------------------------------

Not
applicable.

2

---

---

|D. | Risk
Factors.
|-- | -------------

Investing
in our ordinary shares involves a high degree of risk and uncertainty. You should
carefully consider the risks and uncertainties described below before investing in our
ordinary shares. If any of the following risks actually occurs, our business, prospects,
financial condition and results of operations could be harmed. In that case, the value of
our ordinary shares could decline, and you could lose all or part of your investment.

# Risks Related to Our
Business

Recent worldwide economic downturn may
adversely affect our customers, which directly impacts our business and results of
operations.

Our
operations and performance depend on our customers, including those from the governmental
sector, having adequate resources to purchase our products. The unprecedented turmoil in
the credit markets and the global economic downturn generally adversely impact our
customers and potential customers. These economic conditions have continued to deteriorate
despite government intervention globally, and may remain volatile and uncertain for the
foreseeable future. Customers have altered and may continue to alter their purchasing
activities in response to lack of credit, economic uncertainty and concern about the
stability of markets in general, and have reduced or delayed purchases of our products. As
a result of slow moving inventory due to the global economic slowdown, we may be required
in the future to record additional impairment charges relating to the carrying value of
our intangible assets, increase our reserves for doubtful accounts and further write-down
our tax assets. In addition, the fair value of some of our assets may decrease further as
a result of the weak economy and as a result, we may be required to record further
impairment charges in the future. If we are unable to adequately respond to changes in
demand resulting from deteriorating economic conditions, our financial condition and
operating results may be materially adversely affected.

Failure of our European subsidiary
to complete projects or to collect revenues derived from such projects may cause us
material losses.

Our
recently acquired European subsidiary is engaged in turn-key projects in Africa. These
projects are executed with the assistance of a local subcontractor. Due to lack of
management and financial skills of the subsidiarys employees and to limited physical
access to these projects sites, the European subsidiary encountered difficulties in the
evaluation of the operating results of these projects during their respective execution
periods, as well as in the measurement of the expected costs and resources that will be
necessary to complete them. Insufficient managerial oversight by the local subcontractor
created additional burdens on the subsidiarys management, affecting its ability to
complete these projects. Due to the foregoing reasons and the inherent difficulty in
managing projects in Africa, our European subsidiary may encounter difficulties in the
collection of the revenues associated with such projects. The difficulties described may
also cause delays in the completion of these projects and may result in the imposition of
penalties and the extension of warranties. Any such occurrence could have a material
adverse effect on our business, financial condition and results of operations.

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

3

---

---

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. This risk is heightened during
periods of global economic slowdown.

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

| |  | their
requirements or budgetary constraints change;
| | - | ---------------------------------------------------

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

| |  | they
shift spending priorities into other areas or for other products; and
| | - | --------------------------------------------------------------------------

| |  | they
adjust contract costs and fees on the basis of audits.
| | - | -----------------------------------------------------------

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

The loss of one or more of our key
customers 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, 2007 and 2008, one customer accounted for 13.4% and 18.8%,
respectively, of our revenues. In addition for the years ended December 31, 2006, 2007 and
2008, revenues generated from sales to the Israeli Ministry of Defense, or MOD, accounted
for 33.7%, 13.0% and 8.8%, respectively, of our revenues. The loss of one our more of our
key customers without replacement by a customer or customers of similar volume would have
a material adverse effect on our financial results.

We have identified a material
weakness in our internal control over financial reporting in one of our subsidiaries and
cannot assure you that additional material weaknesses will not be identified in the
future. Our failure to implement and maintain effective internal control over financial
reporting could result in material misstatements in our financial statements.

The
Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors.
Our efforts to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of
2002 governing internal controls and procedures for financial reporting, which started in
connection with our Annual Report on Form 20-F for the year ended December 31, 2006, have
resulted in increased general and administrative expense and a diversion of management
time and attention, and we expect these efforts to require the continued commitment of
significant resources. Section 404 of the Sarbanes-Oxley Act requires (i)
managements annual review and evaluation of our internal control over financial
reporting and (ii) an attestation report by our independent registered public accounting
firm on the effectiveness of our internal control over financial reporting, in connection
with the filing of the Annual Report on Form 20-F for each fiscal year.

Management
has identified a material weakness in our internal control over financial reporting in one
of our subsidiaries as of December 31, 2008. We may identify additional material
weaknesses or significant deficiencies in our internal control over financial reporting in
the future. Any failure to maintain or implement required new or improved controls, or any
difficulties that may be encountered in their implementation, could result in additional
significant deficiencies or material weaknesses or in material misstatements in our
financial statements. Any such failure could also adversely affect the results of our
managements evaluations and annual auditor reports regarding the effectiveness of
our internal control over financial reporting. Failure to maintain or implement effective
internal control over financial reporting could result in investigation or sanctions by
regulatory authorities and could have a material adverse effect on our operating results,
investor confidence in our reported financial information and the market price of our
ordinary shares.

4

---

---

# We may be adversely
affected by our long sales cycles.

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

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.

Our financial results may be
adversely affected by currency fluctuations.

We
sell most of our products in North America, Europe and Israel. Our revenues are primarily
denominated in U.S. dollars, Euros and NIS, while a portion of our expenses, primarily
labor expenses, is incurred in NIS and Canadian Dollars. Additionally, certain assets,
especially trade receivables, as well as part of our liabilities are denominated in NIS.
As a result, fluctuations in rates of exchange between the U.S. dollar and non- U.S.
dollar currencies may affect our operating results and financial condition. The dollar
cost of our operations in Israel may be adversely affected by the appreciation of the NIS
against the U.S. dollar. In addition, the value of our non-U.S. dollar revenues could be
adversely affected by the depreciation of the U.S. dollar against such currencies. In
2006, 2007 and 2008, the NIS appreciated by approximately 8.2%, 9.0% and 1.1%,
respectively, against the U.S. dollar, which had a significant adverse affect on our
results of operations. In 2008, the Euro depreciated against the U.S. dollar by 5.3%,
while in 2007 and 2006, the Euro appreciated against the U.S. dollar by 11.7% and 11.3%,
respectively. In addition, the U.S. dollar cost of our operations in Canada is influenced
by the exchange rate between the U.S. dollar and the Canadian dollar. In 2008, the
Canadian dollar depreciated against the U.S. dollar by approximately 19.7%, while in 2007
and 2006, the Canadian dollar appreciated against the U.S. dollar by 18.4% and 0.4%,
respectively.

During
the years ended December 31, 2007 and 2008, foreign currency fluctuations had an adverse
impact on our results of operations and we recorded foreign exchange losses, net of
$792,000 and $246,000, respectively. Our results of operations may be materially adversely
affected by currency fluctuations in the future.

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

Israels
defense export policy regulates the sale of a number of our systems and products. Current
Israeli policy encourages export to approved customers of defense systems and products,
such as ours, as long as the export is consistent with Israeli government policy. A
license is required to initiate marketing activities. We
are also required to obtain a specific export license for any hardware eventually exported
from Israel. We may not be able to receive all the required permits and licenses for which
we may apply in the future. If we do not receive the required permits for which we apply,
our revenues may decrease.

5

---

---

We
are subject to laws regulating export of dual use items (items that are
typically sold in the commercial market, but that also may be used in the defense market)
and defense export control legislation. Additionally, our participation in governmental
procurement processes in Israel and other countries is subject to specific regulations
governing the conduct of the process of procuring defense contracts. Furthermore,
solicitations for procurements by governmental purchasing agencies in Israel and other
countries are governed by laws, regulations and procedures relating to procurement
integrity, including avoiding conflicts of interest and corruption in the procurement
process. We may not be able to respond quickly and effectively to changing laws and
regulations and any failure to comply with such laws and regulations may subject us to
significant liability and penalties.

We face risks associated with
doing business in international markets.

A
large portion of our sales is to markets outside of Israel. For the years ended December
31, 2006, 2007 and 2008, approximately 58.5%, 78.4% and 82.8%, respectively, of our
revenues were derived from sales to markets outside of Israel. A key component of our
strategy is to continue to expand in such international markets. 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:

| |  | different
and changing  regulatory  requirements in the jurisdictions in which we currently operate
or may                   operate in the future;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | fluctuations
in foreign currency exchange rates;
| | - | ------------------------------------------------

| |  | export
restrictions, tariffs and other trade barriers;
| | - | ------------------------------------------------------

| |  | difficulties
in staffing, managing and supporting foreign operations;
| | - | ---------------------------------------------------------------------

| |  | longer
payment cycles;
| | - | ----------------------

| |  | difficulties
in collecting accounts receivable;
| | - | -----------------------------------------------

| |  | political
and economic  changes,  hostilities and other  disruptions in regions where we currently
sell or                   products or may sell our products in the future; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | seasonal
reductions in business activities.
| | - | -------------------------------------------

Negative
developments in any of these areas in one or more countries could result in a reduction in
demand for our products, the cancellation or delay of orders already placed, difficulty in
collecting receivables, and a higher cost of doing business, any of which could adversely
affect our business, results of operations or financial condition.

We may not be able to implement
our growth strategy and may not be able to successfully integrate the operations of
acquired businesses into our business.

As
part of our growth strategy, we acquire or invest in complementary (including competitive)
businesses, products and technologies. We may not be able to consummate any acquisition or
investment in the future. In addition, 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.

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. Our failure to successfully integrate the operations of an acquired business
or to retain key employees of acquired businesses and integrate and manage our growth may
have a material adverse effect on our business, financial conditions, results of operation
or prospects.

6

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Our due diligence for acquisitions
may not adequately cover all risks.

There
may be liabilities or risks that we fail to discover in performing due diligence
investigations relating to businesses we have acquired or may acquire in the future.
Examples of these liabilities include employee benefit contribution obligations, estimated
costs to complete contracts, environmental liabilities or liabilities for infringement of
third party intellectual property rights for which we, as a successor owner, may be
responsible. Such risks may include changes in estimated costs to complete programs and
estimated future revenues. In addition, there may be additional costs relating to
acquisitions including, but not limited to, possible purchase price adjustments provided
in the applicable acquisition agreement or impairment write downs, if the value of the
acquired company were to decrease after the acquisition, or after follow-on investments in
that company. In addition, any indemnification covenants we may obtain from the sellers of
businesses we acquire may not be applicable, enforceable, collectible or sufficient to
fully offset the possible liabilities. Such liabilities could have a material adverse
effect on our business, financial condition, results of operations or prospects. In
addition, there may be situations in which our management determines, based on market
conditions or other applicable considerations, to pursue an acquisition with limited due
diligence or without performing any due diligence at all.

Reduction in Israeli government
spending or changes in priorities for homeland security products may adversely affect our
financial condition, operating results and prospects.

Historically
a significant portion of our revenues were from sales to the Israeli government and our
financial condition, operating results and prospects would be adversely affected by
Israeli. government budget cutbacks or spending reductions. We believe that the success
and growth of our business will continue to depend to a certain extent upon our successful
procurement of Israeli government contracts. The award of additional contracts from the
Israeli government could be adversely affected by spending reductions or budget cutbacks
at government agencies that currently use or are likely to use our products. The Israeli
government may reduce its expenditures for homeland security or change its defense
priorities in the coming years. Our programs may be affected in the future if there is a
reduction in Israeli government defense spending for our programs or a change in
priorities to products other than ours. Accordingly, changes in government contracting
policies, budgetary constraints and delays or changes in the appropriations process could
have an adverse affect on our business, financial condition and results of operations.

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

Our
success and ability to compete depend in large part upon protecting our proprietary
technology. We have approximately 46 patents and have patent applications pending. We also
rely on a combination of trade secret and copyright law and confidentiality,
non-disclosure and assignment-of-inventions agreements to protect our proprietary
technology. It is our policy to protect our proprietary rights in our products and
operations through contractual obligations, including confidentiality and non-disclosure
agreements with certain employees, distributors and agents, suppliers and subcontractors.
These measures may not be adequate to protect our technology from third-party
infringement, and our competitors may independently develop technologies that are
substantially equivalent or superior to ours. Additionally, our products may be sold in
foreign countries that provide less protection to intellectual property than that provided
under U.S. or Israeli laws.

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

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

7

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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.

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

The
market for our products is characterized by evolving technologies, changing industry
standards, changing regulatory environments, frequent new product introductions and rapid
changes in customer requirements. The introduction of products embodying new technologies
and the emergence of new industry standards and practices can render existing products
obsolete and unmarketable. Our future success will depend on our ability to enhance our
existing products and to develop and introduce, on a timely and cost-effective basis, new
products and product features that keep pace with technological developments and emerging
industry standards and address the increasingly sophisticated needs of our customers. In
the future:

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

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

| |  | our
new products and product  features may not adequately  meet the  requirements  of the
 marketplace and                   achieve market acceptance.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

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

We depend on limited sources for
components utilized in our products, 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 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 in the future, or we may
not be able to obtain them on satisfactory terms. Temporary disruptions of our
manufacturing operations would result if we were required to obtain materials from
alternative sources, which may have an adverse effect on our financial results.

8

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We currently benefit from
government programs and tax benefits that may be discontinued or reduced in the future,
which would increase our future tax expenses.

We
currently benefit from grants and tax benefits under Israeli government programs, which
require us 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 cancelled and
we could be required to refund any payments previously received under these programs,
including any accrued interest, or pay increased taxes or royalties. Such a result would
adversely affect our results of operations and financial condition. 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.

# 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:

| |  | actual
or anticipated variations in our quarterly operating results or those of our competitors;
| | - | ------------------------------------------------------------------------------------------------

| |  | announcements
by us or our competitors of technological innovations or new and enhanced products;
| | - | -------------------------------------------------------------------------------------------------

| |  | developments
or disputes concerning proprietary rights;
| | - | -------------------------------------------------------

| |  | introduction
and adoption of new industry standards;
| | - | ----------------------------------------------------

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

| |  | market
conditions or trends in our industry;
| | - | --------------------------------------------

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

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

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

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

| |  | political
and economic  conditions,  such as a recession or interest rate or currency rate
fluctuations or                   political events; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------

| |  | other
events or factors in any of the countries in which we do business, including those
resulting from war, incidents of terrorism, natural disasters or responses to such
events.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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. In the past, following periods of market
volatility, shareholders have often instituted securities class action litigation relating
to the stock trading and price volatility of the software company in question. If we were
involved in any securities litigation, it could result in substantial cost to us to defend
and divert resources and the attention of management from our business.

We do not expect to distribute
dividends in the foreseeable future.

We
currently intend to retain our current and any future earnings to finance operations and
expand our business and, therefore, do not expect to pay any dividends in the foreseeable
future. According to the Israeli Companies Law, a company may distribute dividends out of
its profits (as defined by the Israeli Companies Law), provided that there is no
reasonable concern that such dividend distribution will prevent the company from paying
all its current and foreseeable obligations, as they become due, or otherwise upon the
permission of the court. In the event cash dividends are declared, such dividends will be
paid in NIS. The declaration of dividends is subject to the discretion of our board of
directors and would depend on various factors, including our operating results, financial
condition, future prospects and any other factors deemed relevant by our board of
directors. You should not rely on an investment in our company if you require dividend
income from your investment.

9

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# Risks Relating to Our
Location in Israel

Political, economic and military
instability in Israel may disrupt our operations and negatively affect our business
condition, harm our results of operations and adversely affect our share price.

We
are incorporated under the laws of, and our principal executive offices and manufacturing
and research and development facilities are located in, the State of Israel. As a result,
political, economic and military conditions affecting Israel directly influence us. 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, or a significant downturn in the economic or financial condition
of Israel could have a material adverse effect on our business, financial condition and
results of operations.

Since
the establishment of the State of Israel in 1948, Israel and its Arab neighbors have
engaged in a number of armed conflicts. A state of hostility, varying from time to time in
intensity and degree, has led to security and economic problems for Israel. Major
hostilities between Israel and its neighbors may hinder Israels international trade
and lead to economic downturn. This, in turn, could have a material adverse effect on our
operations and business. Since September 2000, there has been an increase in unrest and
terrorist activity in Israel of varying levels of severity. In recent years, there has
been an escalation in violence among Israel, Hamas, Hezbollah, the Palestinian Authority
and other groups. There were extensive hostilities along Israels northern border
with Lebanon in the summer of 2006. Since June 2007, when Hamas effectively took control
of the Gaza Strip, there have been extensive hostilities along Israels border with
the Gaza Strip. Hamas has launched hundreds of missiles from the Gaza Strip against
Israeli population centers, which led to an armed conflict between Israel and Hamas during
December 2008 and January 2009. The recent violence has generally taken a toll on Israeli
business overseas. Ongoing violence between Israel and the Palestinians as well as tension
between Israel and neighboring Syria and Lebanon or Iran may have a material adverse
effect on our business, financial conditions and results of operations.

Political relations could limit
our ability to sell our services and products or obtain components internationally.

We
could be adversely affected 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 companies and others doing business with Israel or with Israeli
companies. As a result, we are precluded from marketing our products to these countries,
companies and organizations. Foreign government defense export policies towards Israel
could also make it more difficult for us to obtain the export authorizations necessary for
our activities. Also,
over the past several years there have been calls in Europe and elsewhere to reduce trade
with Israel. Restrictive laws, policies or practices directed towards Israel or Israeli
businesses may have an adverse impact on our operations, our financial results or the
expansion of our business.

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

Many
of our employees and some of our directors and officers in Israel are obligated to perform
annual reserve duty in the Israeli Defense Forces and may be 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.

10

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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.

Service and enforcement of legal
process on us and our directors and officers may be difficult to obtain.

Service
of process upon our directors and officers and the Israeli experts named herein, all of
whom reside outside the United States, may be difficult to obtain within the United
States. Furthermore, since substantially all of our assets, all of our directors and
officers and the Israeli experts named in this annual report are located outside the
United States, any judgment obtained in the United States against us or these individuals
or entities may not be collectible within the United States.

There
is doubt as to the enforceability of civil liabilities under the Securities Act and the
Securities Exchange Act in original actions instituted in Israel. However, subject to
certain time limitations and other conditions, Israeli courts may enforce final judgments
of United States courts for liquidated amounts in civil matters, including judgments based
upon the civil liability provisions of those and similar acts.

As a foreign private issuer whose
shares are listed on the NASDAQ Global Market, we may follow certain home country
corporate governance practices instead of certain NASDAQ requirements. We follow Israeli
law and practice instead of NASDAQ rules regarding the director nomination process,
compensation of executive officers and the requirement that our independent directors have
regularly scheduled meetings at which only independent directors are present.

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

11

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|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 United States is Senstar Inc.,
13783 Park Center Road, Suite 316, Herndon, Virginia 20171. 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
are a leading international solutions provider of safety, security, site management and
intelligence gathering and compilation. Based on 35 years of experience and interaction
with customers, we have developed a unique set of solutions and products, optimized for
perimeter, outdoor and general security applications. Our turnkey solutions are typically
integrated and managed by sophisticated modular command and control software, supported by
expert systems for real-time decision support. Our portfolio of critical infrastructure
protection and site protection technologies includes a variety of smart barriers and
fences, fence mounted detectors, virtual gates, buried and concealed detection systems and
a sophisticated protection package for sub-surface intrusion. A world innovator in the
development of CCTV, intelligence video analysis and motion detection technology for
outdoor operation, we have successfully installed customized solutions and products in
more than 75 countries worldwide.

Due
to the need to reduce cost and operate more efficiently and effectively, we resolved to
merge certain activities that were operated out of different locations in North America.
As a result, we have merged the manufacturing, product development and technical support
function of our California subsidiary with our operations in Ottawa, Canada. All products
that are manufactured in the United States through subcontractors will continue to be
produced by subcontractors, however the process will be managed out of our facilities in
Ottawa, Canada. The sales and marketing activity of our California subsidiary have been
moved to and will be managed from our office in Herndon, Virginia, which is in the
Washington, D.C. metropolitan area. The transitions described above were completed in June
2009. A small team of seven people are still operating temporarily out of our facility in
Fremont, California. Our building in Fremont, California has been put up for sale or for
lease.

Recent
key personnel changes. On December 31, 2007, the former Chairman of our Board of
Directors, Mr. Jacob Even-Ezra, retired from such position and was replaced by Mr. Jacob
Perry, who has served as the Chairman of our Board of Directors since January 1, 2008. On
November 10, 2008, Mr. Izhar Dekel, our former President and chief executive officer and a
former director, resigned from such offices. Mr. Dekel remained with our company for a
transition period until February 27, 2009. Mr. Yoav Stern was appointed as our acting
President as of November 10, 2008 and as our acting President and chief executive officer
as of March 1, 2009, and he served in such positions until May 2009. On June 3, 2009, our
Board of Directors appointed Mr. Eitan Livneh as our President and chief executive
officer, commencing August 2, 2009. On April 16, 2009, Ms. Lian Goldstein, our former Vice
President  Finance and chief financial officer, resigned from such office and was
replaced by Mr. Zev Morgenstern. On May 4, 2009, Mr. Dany Pizen, our Vice President 
East European and CIS Marketing retired from such position. On January 1, 2009, Mr. Hagai
Katz joined us as Senior Vice President  Marketing and Products, General Manager of
the Israeli Division and Chief Information Officer. At the same time, Mr. Asaf Even Ezra,
previously Executive Vice President  Marketing and Sales, assumed the position of
Senior Vice President  Sales. In December 2008, we also replaced the senior
personnel in our research and development department. Mr. Yehonatan Ben Hamozeg was
appointed as Senior Vice President  Product Development and Projects and Mr. Zvi
Dank, formerly our Vice President  Research and Development, retired from such
position in March 2009.

12

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Capital
expenditures. Our capital expenditures for the years ended December 31, 2006, 2007
and 2008 were approximately $906,000, $890,000 and $1.7 million, respectively. These
expenditures were principally for the renovation and expansion of our offices and
production facilities in Israel, as well as for computers, other machinery, commercial
vehicles and equipment. The increase in our capital expenditures in 2008 compared with
2007 is primarily attributable to major renovations at our offices and factory in Israel
in 2008 and due to increased capital expenditures attributable to our new European
integration company that we acquired in September 2007.

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

# Overview and Strategy

We
develop, manufacture, market and sell complex computerized security systems. Our systems
are used in more than75 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.

Based
on 35 years of experience and interaction with customers, we have developed a
comprehensive set of solutions and products, optimized for perimeter, outdoor and general
security applications. Our turnkey solutions are typically integrated and managed by a
single sophisticated modular command and control software, supported by expert systems for
real-time decision support. Our portfolio of mission critical infrastructure and site
protection technologies includes a variety of smart barriers and fences, fence mounted
detectors, virtual gates, buried and concealed detection systems and a sophisticated
protection package for sub-surface intrusion. We have successfully installed customized
solutions and products in more than 75 countries worldwide.

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 offer comprehensive turnkey security solutions that provide a
comprehensive security implementation process. This process entails: in-depth threat
analysis; determination of the appropriate hardware and software solutions; training
sessions for systems operators; and upon customer approval, integration of the required
systems into our security management and control systems. 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.

Our
revenues are principally derived from:

| |  | installation
of comprehensive security systems for which revenues are generated from long-term fixed
              price contracts;
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | sales
of security products; and
| | - | -------------------------------

| |  | services
and maintenance, which are performed either on a fixed-price basis or as
time-and-materials               based contracts.
| | - | -----------------------------------------------------------------------------------------------------------------------------------

Our
primary objective is to become a leading international solution provider of safety,
security, site management and intelligence gathering and compilation. 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 customized enhancements for specific projects.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Enter
New Markets and Strengthen Presence in Existing Markets. We intend to continue
to penetrate new geographic markets by various means, including the establishment of
alliances with local distributors and international integrators of security systems. 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13

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

# 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 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 600correctional institutions in the United
States and correctional institutions in several other countries. In addition, we have
installed several hundred kilometers of high security electronic perimeter systems along
Israels borders.

Our
line of perimeter security systems consists of the following:

| |  | taut
wire perimeter intrusion detection systems;
| | - | ------------------------------------------------

| |  | vibration
detection systems;
| | - | ----------------------------

| |  | field
disturbance sensors;
| | - | --------------------------

| |  | video
analytics and video motion detection systems;
| | - | ---------------------------------------------------

| |  | the
MTC-1500E and the MSS-1500 thermal and optical cameras;
| | - | -----------------------------------------------------------

| |  | buried
cable sensors; and
| | - | -------------------------

| |  | copper
wire sensors.
| | - | --------------------

Taut Wire Perimeter
Intrusion Detection Systems

Our
taut wire perimeter 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 (such as by cutting)
that is not 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.

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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 kilometersof 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-$150 per
meter.

Vibration Detection
Systems

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

Intelli-FLEX,
Intelli-FIBER and fence protection systems, or FPS, microprocessor-based triboelectric and
electric cable fence sensors are vibration sensitive transducers. These systems detect any
attempt to cut, climb or penetrate the fence and have microphonic properties. The
microphonic feature permits audio to be used for low-cost alarm assessment, providing
users with an additional tool for determining the nature of an attempted intrusion. Our
vibration detection system is sold for between $9-$60 per meter.

Field Disturbance Sensors

We
offer a number of types of field disturbance sensors that detect intrusions before the
intruder touches the sensor. Our line of field disturbance sensors consists of the
following:

| |  | The
Intelli-Field volumetric electronic field disturbance sensor can be installed outdoors on
perimeter systems, buildings or as free-standing units. The Intelli-Field system is sold
for approximately $95-$160 per meter. Omnitrax is a fifth generation, covert outdoor
perimeter security intrusion detection sensor that generates an invisible radar detection
field around buried sensor cables. An alarm is emitted and the exact location identified
within one meter if an intruder disturbs the field. Targets are detected by their
conductivity, size and movement and the digital processor is able to filter out common
alarms caused by environmental conditions and small animals. The Omnitrax system is sold
for approximately $40-$60 per meter.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | X-Field
is a terrain following, volumetric sensor that creates an electrostatic field around a
set of four or eight parallel field and sense wires. These wires can be mounted on
free-standing poles, existing fences, walls or rooftops and will sense changes, via
the processor, in the electrostatic field when events such as intruders penetrating
through the wires take place. The systems tall, narrow, well contained detection
zone allows the sensor to be installed in almost any application and minimizes nuisance
alarms caused by nearby moving objects. The X-Field system is sold for approximately
$100-$130 per meter.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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We
have installed high-security taut wire electronic perimeter systems over several hundred
kilometers of Israels borders and have sold a number of our high-security perimeter
systems to protect other locations in Israel, including Ben-Gurion International Airport,
facilities of Israel Aircraft Industries Ltd., or IAI, and the Israel Electric Company,
industrial plants, prisons, refineries, ports and military bases. Outside Israel, our
high-security perimeter systems have been purchased to protect various sites, including
military installations, airports, ports, 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, Africa 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. Few
of these airports utilize a system manufactured by us. In marketing our high-security
perimeter systems, we target authorities responsible for airport security. To date, we
have sold and installed perimeter systems at certain airports in Israel, Europe, the
United States 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, South America and the Far East.

The
IDF has tested our perimeter security products along with those of several of our
competitors and our system and two competitors systems were the only systems to be
approved for participation in the MODs bid for perimeter security systems.

Video analytics and video
motion detection systems

The
DreamBox is a state-of-the-art embedded hardware and software product, which integrates a
number of CCTV related applications into one box. The system is designed to be economical,
as well as compact to save space, by avoiding the use of a complicated cable installation
and integration. It contains 12 different applications, including a digital video and
audio recording, video and audio matrix switcher, outdoor and indoor video motion
detection, or VMD, system, 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.

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. One of the
DreamBoxs applications has allowed us to enter the field of digital video recording.

MTC-1500E

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

16

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MSS-1500

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

Security Management and
Control Systems

The
deployment of multiple security systems creates the need for a system that can manage and
control these systems through a single database. In response to this need, we offer MagNet
and Fortis, security management and control systems that integrate the management, control
and display of various security systems, both outdoor, such as perimeter security systems,
and indoor, such as fire detection, entry monitoring and alarm systems, into a single,
real-time database, and support real-time decision making and wide area command and
control. These systems were developed to improve the response to real-time security events
by sharing video and geographical information between the control center and security
personnel acting in the field. Since their introduction, we have sold our security
management systems and provided turnkey projects to several customers, including large
international companies and international airports.

MagNet 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.

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.

Fortis 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.

17

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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
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 2008, 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. 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.

PipeGuards
target market includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies dealing with security and environment. 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.

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

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

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 United States and competes against infrared and ultrasonic
technologies.

18

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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.

# Marketing, Sales and
Distribution

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.

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

We
have marketing and sales offices located in Herndon, Virginia (in the Washington D.C.
metropolitan area), Ottawa, Canada, Cuernavaca, Mexico, the United Kingdom, Germany, China
and Israel. These offices serve the growing needs of local, state and federal homeland
security requirements. These offices focus exclusively on providing a comprehensive
security architecture for perimeter applications, which is comprised of command and
control, physical security sensors, and intelligent video. The office hosts a
solution center demonstrating several of our advanced sensor solutions for
intrusion detection, pipeline infiltration, intelligent video surveillance, multi-sensor
command and control, as well as integration of our leading perimeter sensors, with
advanced intelligent video for real time decision support on the response to possible
intrusions.

Perimeter Intrusion
Detection Systems

We
generally sell our perimeter intrusion detection systems to distributors and systems
integrators for various geographic territories or for specific projects. These
distributors and system integrators 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 and system integrators also provide installation and maintenance services for
our products. We currently have over 50distributors and system integrators who
resell these systems. We occasionally use agents to find suitable distributors and pay
finders fees to these agents for their services.

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
United States and Canada through our U.S. and Canadian subsidiaries.

Pipeline Security Systems

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

Personal Emergency
Location Systems

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

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The
following table shows the breakdown of our consolidated revenues for the calendar years
2006, 2007 and 2008 by operating segment:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

# Customers

The
following table shows the geographical breakdown of our consolidated revenues for the
calendar years 2006, 2007 and 2008:

|                        | Year Ended December 31,
|----------------------- | -----------------------
|
|
|
|
|Israel                  |                        
|North America           |                        
|Europe                  |                        
|South and Latin America |                        
|Africa                  |                        
|Others                  |                        
|                        |                        
|Total                   |                        
|                        |                        
|                        |                        

For
the years ended December 31, 2007 and 2008, one customer accounted for 13.4% and
18.8%, respectively, of our revenues. In addition, for the years ended December 31,
2006, 2007 and 2008, revenues generated from sales to the MOD and IDF, accounted for
33.7%, 13% and 8.8%, 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.

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.

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During
2008, we derived approximately 6.5% of our total revenues from maintenance and services.
We generally provide a 12 to 24 months warranty on most of our products.

# 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 2006, 2007 and 2008 were approximately $5.5
million, $5.9 million and $6.4 million, respectively, which were offset by Canadian
investment tax credits of approximately $162,000 , $160,000 and $234,000, respectively. 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 two development centers, each of which develops products and
technologies based on its area of expertise:

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

| |  | In
Canada  we develop our leaky coax radar, triboelectric and fiber-optic fence
sensors, electrostatic volumetric detection, medium to high-end control systems, personal
emergency location systems, microwave detection, personal alarm systems and small to
medium control systems.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Office of the Chief
Scientist of the Israeli Ministry of Industry, Trade and Labor

We
have historically sought co-financing of our development projects from the Office of the
Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or the OCS. We are
obligated to pay royalties to the OCS, amounting to 3% to 4.5% of revenues derived from
sales of the products funded with these grants and ancillary services, 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 equal to the 12 month LIBOR rate. 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 $79,000, $143,000 and
$125,000 in the years ended December 31, 2006, 2007 and 2008, respectively. As of
December 31, 2008, our aggregate contingent obligation to the OCS amounted to $1.37
million.

The
terms of these grants require that the manufacture of products developed with these grants
be performed in Israel and prohibit transferring technology developed with grants without
the prior consent of the Research Committee of the OCS. We cannot assure you that, if
requested, the OCS will grant such consent. Each application to the OCS is reviewed
separately, so we cannot assure you that the Israeli Government will continue to support
our research and development.

# 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 and in Ottawa, Canada. See Item 4D., Information on the Company 
Property, Plants and Equipment.

21

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We
acquire most of the components utilized in our products, including our turnkey products,
and certain services from a limited number of suppliers and subcontractors. We cannot
assure you that we will continue to be able to obtain such items from these suppliers on
satisfactory terms. Alternative sources of supply are available, and therefore, we are not
dependent upon these suppliers and subcontractors. We also maintain an inventory of
systems and spare parts in order to enable us to overcome potential temporary supply
shortages until an alternate source of supply is available. Nevertheless, temporary
disruptions of our manufacturing operations would result if we were required to obtain
materials from alternative sources, which may have an adverse effect on our financial
results.

Our
North American manufacturing operations are located at our facility in Carp, Ontario,
Canada and consist of design and development, assembly, final testing and quality control.
We use local subcontractors for producing and mounting our printed circuit board
assemblies. Prior to May 31, 2009, our U.S. manufacturing operations were located at our
facility in Fremont, California, at which time such operations were integrated into our
manufacturing operations located in Carp, Ontario, Canada.

# Competition

The
principal factors affecting competition in the market for security systems are a
systems high probability for detection and low probability of false and nuisance
alarms. We believe that a manufacturers reputation for reliable equipment is a major
competitive advantage, and that such a reputation will usually be based on the performance
of the manufacturers installed systems. Additional competitive factors include
quality of customer support, maintenance and price. We believe that we are competitive
with respect to these factors and that we have a good reputation in the markets in which
we compete.

Several
companies, including Elbit Systems Ltd., Elfar Ltd. and RB-Tec Ltd. in Israel, and
Del-Norte Security, Detektion Security Systems Inc., Geoquip Ltd., Herras, Remsdaq,
Siemens AG and Southwest Microwave Inc. outside of Israel, produce high-security detection
systems.

There
are a number of companies that have developed video motion detection systems, including
Bosch, Geutebruck GmbH, Ioimage Ltd., Nice Systems Ltd., ObjectVideo Inc., Siemens AG and
Xtralis.

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

We
believe that our principal competitors for security management and control systems and
turnkey project offerings include, among others, Dornier, EADS N.V., Elbit Systems Ltd.,
Honeywell Inc., Lockheed Martin Corporation, Rafael Advanced Defense Systems Ltd, Raytheon
Company, Siemens AG, Thales and 4D.

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.

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.

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# Intellectual Property
Rights

We
have approximately 46 patents issued and have patent applications pending in the United
States and in several other countries and have obtained licenses to use proprietary
technologies developed by third parties. We cannot assure you:

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

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

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

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

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

# Government Regulations

Israels
defense export policy regulates the sale of a number of our systems and products. Current
Israeli policy encourages export to approved customers of defense systems and products,
such as ours, as long as the export is consistent with Israeli government policy. A
license is required to initiate marketing activities. We
are also required to obtain a specific export license for any hardware eventually exported
from Israel. We cannot assure you that we will receive all the required permits and
licenses for which we may apply in the future.

In
2007, an Israeli law regulating export of dual use items (items that are
typically sold in the commercial market, but that also may be used in the defense market)
came into effect. In addition, a new Defense Export Control Law was adopted in 2007 and
the laws supplemental regulations became effective in February 2008. The new
regulations and law enhance enforcement of export control legislation, provide certain
exemptions from license requirements and broaden certain areas of licensing, particularly
with respect to transfer of technology. In addition, our participation in governmental
procurement processes in Israel and other countries is subject to specific regulations
governing the conduct of the process of procuring defense contracts. Furthermore,
solicitations for procurements by governmental purchasing agencies in Israel and other
countries are governed by laws, regulations and procedures relating to procurement
integrity, including avoiding conflicts of interest and corruption in the procurement
process.

In
addition, antitrust laws and regulations in Israel and other countries often require
governmental approvals for transactions that are considered to limit competition. Such
transactions may include cooperative agreements for specific programs or areas, as well as
mergers and acquisitions.

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

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

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

Our
principal facility in Israel is a two-story 2,533 square meter facility located on a 4,352
square meter parcel in the Yehud Industrial Zone. Approximately 600 square meters are
devoted to administrative, marketing and management functions and approximately 700 square
meters are used for engineering, system integration and customer service. We use the
remaining 1,233 square meters for production management, production operations, including
manufacturing, assembly, testing, warehousing, shipping and receiving. In accordance with
Israeli law, this parcel of land is still registered in the name of the Israel Land
Authority. However, we have received the necessary approval and will be entitled to have
title to the property recorded in our name when Israeli authorities subdivide the property
into parcels. Such subdivision has been concluded and we are now in the final stages of
the recordation. This procedure is a statutory requirement for transferring land ownership
in Israel. In 2007, we entered into a lease for a one-story 810 square meter facility
located on a 1,820 square meter parcel in the Yehud Industrial Zone for $80,000 per year
for use in production and operations. The lease is for a period of 23 years. The products
that we manufacture at our facilities in the Yehud Industrial Zone include our taut-wire
intrusion detection systems, our vibration detection systems, our video-motion detection
systems, MagNet, Fortis, DreamBox, PipeGuard, MTC-1500, MSS-1500 and other perimeter
systems.

We
own a 33,000 square foot facility in Carp, Ontario, Canada. Approximately 7,000 square
feet are devoted to administrative, marketing and management functions and approximately
8,000 square feet are used for engineering, system integration and customer service. We
use the remaining 18,000 square feet for production operations, including cable
manufacturing, assembly, testing, warehousing, shipping and receiving. We own an
additional 182,516 square feet of vacant land adjacent to this property, which is being
held for future expansion. We also rent 358,560 square feet of land near this facility for
use as an outdoor sensor test and demonstration site for our products including the
Perimitrax/Panther 2000 and Omnitrex buried cable intrusion detection systems, the
Intelli-Field electro static detection system, the X-Field volumetric system the
Intelli-FLEX microphonic fence detection system, Flash and Flare, and various perimeter
monitoring and control systems. The rent for this site is Canadian $2,500 per year under a
lease that expires in November 2009, which is renewable for an additional ten years. In addition, we lease a 1,900 square foot
facility adjacent to our Carp, Ontario property for Canadian $20,000 per year for use as
additional storage and system integration space under a month to month tenancy.

We
own a 20,000 square foot facility in Fremont, California that formerly served as a
manufacturing and sales facility. We are currently seeking to sell this facility.

We
lease 2,793 square feet of office space in Herndon, Virginia at a cost of $5,754 per
month. The lease commenced on December 1, 2006 and will terminate on November 30, 2010. We
utilize this space, which houses marketing demo rooms, as a sales office for our U.S.
subsidiary.

We
also lease small offices in Germany, the United Kingdom, Mexico and Romania for our sales
and marketing entities. The aggregate annual rent for such offices was approximately $0.2
million in 2008.

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

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

None.

|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.

24

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

Overview

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

| |  | installation
of comprehensive security systems for which revenues are generated from long-term fixed
                  price contracts;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | sales
of security products; and
| | - | -------------------------------

| |  | services
and maintenance, which are performed either on a fixed-price basis or as
time-and-materials                   based contracts.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

Business Challenges/Areas
of Focus

Our
recently acquired European subsidiary is engaged in turn-key projects in Africa. These
projects are executed with the assistance of a local subcontractor. Due to lack of
management and financial skills of the subsidiarys employees and to limited physical
access to these projects sites, the European subsidiary encountered difficulties in the
evaluation of the operating results of these projects during their respective execution
periods, as well as in the measurement of the expected costs and resources that will be
necessary to complete them. Insufficient managerial oversight by the local subcontractor
created additional burdens on the subsidiarys management, affecting its ability to
complete these projects. Due to the foregoing reasons and the inherent difficulty in
managing projects in Africa, our European subsidiary may encounter difficulties in the
collection of the revenues associated with such projects. The difficulties described may
also cause delays in the completion of these projects and may result in the imposition of
penalties and the extension of warranties. Any such occurrence could have a material
adverse effect on our business, financial condition and results of operations.

In
addition to the above, our primary business challenges and areas of focus include:

| |  | continuing
the growth of revenues and profitability of our perimeter security system line of
products;
| | - | ------------------------------------------------------------------------------------------------------

| |  | enhancing
the introduction and recognition of our new products into the markets;
| | - | --------------------------------------------------------------------------------

| |  | penetrating
into new markets and strengthening our presence in existing markets; and
| | - | ------------------------------------------------------------------------------------

| |  | succeeding
in selling our comprehensive turnkey solutions.
| | - | ----------------------------------------------------------

Our
business is subject to the effects of general global economic conditions. If general
economic conditions fail to improve, or if they deteriorate, demand for our products could
be adversely affected.

25

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Key Performance
Indicators and Sources of Revenues

Our
management believes that our revenues, sources of revenues and operating income are among
the key performance indicators for our business. Our revenues from our principal lines of
business for the three years ended December 31, 2006, 2007 and 2008 were as follows:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

Our
operating income (loss) from our principal lines of business for the three years ended
December 31, 2006, 2007 and 2008 were as follows:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|Eliminations       |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

Cost and Expenses

Cost
of revenues.Our cost of revenues for perimeter products consists of
component and material costs, direct labor costs, shipping expenses, overhead related to
manufacturing and depreciation. Our cost of revenues for turnkey projects consists
primarily of component and material costs, subcontractor costs, direct labor costs and
overhead related to the turnkey projects. Our cost of revenues for other
consists primarily of direct labor costs and material costs relating to our maintenance
services.

Our
gross margin is affected by the proportion of our revenues generated from perimeter
products, turnkey projects and other. Our revenues from perimeter products generally have
higher gross margins than our other segments.

Research
and development expenses, net. Research and development expenses, net
consists primarily of expenses for on-going research and development activities and other
related costs.

Selling
and marketing expenses.Selling and marketing expenses consist primarily of
commission payments, compensation and related expenses of our sales teams, attendance at
trade shows and advertising expenses and related costs for facilities and equipment.

General
and administrative expenses. Our general and administrative expenses
consist primarily of salary and related costs associated with our executive and
administrative functions, legal and accounting expenses, allowances for doubtful accounts
and bad debts and other miscellaneous expenses. Staff costs include direct salary costs
and related costs, such as severance pay, social security and retirement fund
contributions, vacation and other pay.

26

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Depreciation
and Amortization.The amount of depreciation and amortization attributable
to our business segments for the years ended December 31, 2006, 2007 and 2008 are as
follows:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

Financial
Expenses, Net. Financial expenses, net include exchange rate differences arising from
changes in the value of monetary assets and monetary liabilities stated in currencies
other than the functional currency of each entity, interest charged on loans from banks as
well as interest income on our cash and cash equivalents and short term investments.

Tax
expense. Tax expense consists of federal, state and local taxes on the
income of our business. Our taxable income in Israel was subject to corporate tax at the
statutory rate of 29% in 2007 and 27% in 2008. The applicable rate for 2009 is 26% and
from 2010 onward the tax rate will be 25%.

# 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 (i) installation of comprehensive security systems for
which revenues are generated from long-term fixed price contracts; (ii) sales of security
products; and (iii) services and maintenance, which are performed either on a fixed-price
basis or as time-and-materials based contracts.

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

Project
costs include materials purchased to produce the system, related labor and overhead
expenses and subcontractors costs. The percentage to completion is measured by
monitoring costs and efforts devoted using records of actual costs incurred to date in the
project compared to the total estimated project requirement, which corresponds to the
costs related to earned revenues. The amounts of revenues recognized are based on the
total fees under the agreements and the percentage of completion achieved. Provisions for
estimated losses on uncompleted contracts are made in the period in which such losses are
first determined, in the amount of the estimated loss on the entire contract.

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

27

---

---

We
believe that the use of the percentage of completion method is generally 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, executed contracts 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
most cases we expect to perform our contractual obligations and our customers are expected
to satisfy their obligations under the contract.

Fees
are payable upon completion of agreed upon milestones and subject to customer acceptance.
Amounts of revenues recognized in advance of contractual billing are recorded as unbilled
accounts receivable. The period between most instances of advanced recognition of revenues
and the customers billing generally ranges between one to six months. As of December
31, 2008, we had recorded $5.1 million of such unbilled receivables.

Although
our basic accounting policy is percentage-of-completion, the completed-contract method is
used for certain contracts when we cannot make reasonably dependable estimates for such
contracts or if inherent hazards make estimates doubtful. Inherent hazards are conditions
and events that do not occur in the normal course of business. Under the
completed-contract method, billings and costs are accumulated on the balance sheet under
the caption cost incurred on long term contracts while the contract is in
progress, but no revenue is recognized until the contract is completed or substantially
completed. When revenues and costs are recognized based upon substantial completion of the
contract, an accrual is recorded for the estimated remaining costs to be incurred and for
the estimated amounts of any unresolved claims or disputes related to the contract that
are probable of payment. During 2008, we concluded that the projects in Africa are not
typical compared to our other projects and identified inherent hazards related to these
projects and a delay in payments from the customer. As a result, we concluded that we
cannot make reasonably dependable estimates in order to calculate the percentage of
completion of these projects and therefore, in 2008 we began to apply the completed
contract method to these projects.

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

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

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

Inventories

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

| |  | Raw
materials, parts and supplies  using the first-in, first-out method.
| | - | ---------------------------------------------------------------------------

| |  | Work-in-progress
and finished products  on the basis of direct manufacturing costs with the addition
of allocable indirect manufacturing costs.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

28

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During
2006, 2007 and 2008, we recorded inventory write-offs from continuing operations in the
amounts of $760,000, $646,000 and $2.0 million, respectively. Such write-offs were
included in cost of revenues.

Income taxes

We
account for income taxes in accordance with Financial Accounting Standards Board, or FASB,
Statement of Financial Accounting Standard, or SFAS, 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 our deferred tax assets to the amount that is more likely than not to
be realized. Increases in the valuation allowance result in additional expense to be
reflected within the tax provision in the consolidated statement of income.

At
December 31, 2008, we had a deferred tax asset of $269,000 attributable to our
subsidiaries and had total estimated available carryforward tax losses of $14.9 million.
As of December 31, 2008, we recorded a full valuation allowance on these carryforward tax
losses due to the uncertainty of their future realization. As of December 31, 2008, our
subsidiaries had estimated total available carryforward tax losses of $9.1 million, which
may be used as an offset against future taxable income for periods ranging between 13-20
years. As of December 31, 2008, we recorded a valuation allowance for most of our
subsidiaries carryforward tax losses 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 excess of the costs over the net fair value of the assets of the businesses
acquired. FASB SFAS No. 142, Goodwill and Other Intangible Assets
requires goodwill to be tested for impairment at least annually or between annual tests in
certain circumstances, and written down when impaired, rather than being amortized. SFAS
142 prescribes a two phase process for impairment testing of goodwill. The first phase
screens for impairment, while the second phase (if necessary) measures impairment. In the
first phase of impairment testing, 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. If the carrying value of the reporting unit exceeds its fair value, the second
phase is then performed. The second phase of the goodwill impairment test compares the
implied fair value of the reporting units goodwill with the carrying amount of that
goodwill. If the carrying amount of the reporting units goodwill exceeds the implied
fair value of that goodwill, an impairment loss is recognized in an amount equal to that
excess. 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 2005, 2006 and 2007, no impairment losses have been identified.

In
2008, following our annual impairment test of goodwill, we determined that the fair value
of our European subsidiary had decreased and that as a result, goodwill in the amount of
$8.4 million established in connection with its acquisition in September 2007 had been
impaired. Following the 2008 annual impairment test, we also determined that the fair
value of our U.S. subsidiary had significantly declined and that as a result, goodwill in
the amount of $2.4 million attributable to the subsidiary had been impaired. During 2006
and 2007, no impairment losses were identified.

29

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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
2006 and 2007, no impairment losses were identified. In 2008, we determined that
intangible assets attributable to customers of our European subsidiary in the amount of
$1.7 million had been impaired, and as a result, we recorded an impairment charge of $1.7
million attributable to such intangible assets. As of December 31, 2008, following such
impairment, we had $2.5 million of intangible assets attributable to customers of our
European subsidiary. In addition, impairment of other intangible assets amounted to
approximately $350,000 in 2008 attributable to the write-off of certain know-how.

Functional Currency and
Financial Statements in U.S. Dollars

We
have determined that our reporting currency is the U.S. dollar. As of October 1, 2006, our
functional currency changed from the U.S. dollar to NIS. Translation adjustments resulting
from translating our financial statements from NIS to the U.S. dollar are reported as a
separate component in shareholders equity. As of December 31, 2006, 2007 and 2008
our foreign currency translations totaled $297,000, $2.6 million and $3.3 million,
respectively.

Accordingly,
as of December 31, 2006, 2007 and 2008, we recorded accumulated foreign currency
translation income of approximately $2.3, $5.8 million and $2.5 million, included in our
balance sheets as part of accumulated other comprehensive income. As of 2006,
2007 and 2008, foreign currency translation adjustments, net of ($72,000), $3.5 million
and ($3.4 million), respectively, were included under accumulated other
comprehensive income. Had we determined that the functional currency of our
subsidiaries (not including our U.S. subsidiaries) was the U.S. dollar, these gains would
have increased our income for each of the years presented.

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

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

Concentrations of credit
risk

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

Of
our cash and cash equivalents, marketable securities and short-term and long-term bank
deposits at December 31, 2008, $ 14.6 million was invested in major Israeli and U.S. banks
and approximately $10.4 million was invested in other banks, mainly with Deutsche Bank,
Commerzbank, Leutkircher Bank, Natwest Bank and RBC Royal Bank. Cash and cash equivalents
invested in the United States may be in excess of insured limits and are not insured in
other jurisdictions. Generally these deposits maybe redeemed upon demand and therefore
bear low risk. Our marketable securities include investments in U.S. corporate bonds.

30

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The
short-term and long-term trade receivables and the unbilled accounts receivable of our
company and our subsidiaries are derived from sales to large and solid organizations
located mainly in Israel, the United States, Canada, Mexico and Europe. We perform ongoing
credit evaluations of our customers and to date have not experienced any material losses.
An allowance for doubtful accounts is determined with respect to those amounts that we
have determined to be doubtful of collection and in accordance with an aging policy. In
certain circumstances, we may require letters of credit, other collateral or additional
guarantees. During the years ended December 31, 2006, 2007 and 2008, we recorded $138,000,
($68,000) and $1,223,000 of expenses (income) related to doubtful accounts, respectively.
The increase in expenses related to doubtful accounts in 2008 is primarily a result of the
recent global economic downturn, which has had an adverse influence on the liquidity of
some of our clients. As of December 31, 2008, our allowance for doubtful accounts amounted
to $1.5 million.

A
loan granted to a third party entity in connection with a possible future cooperation
between us and the entity is secured by a personal guarantee of the beneficial owner of
the entity. However, we evaluated the anticipated repayment of the loan and due to
anticipated difficulties in implementation of the projects for which the loan was
provided, we estimated that 50% of the loan will not be repaid and therefore, recorded a
provision of $550,000 attributable to the loan. See Note 11h to the consolidated financial
statements.

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

Derivative instruments

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

To
protect against the change in the forecasted foreign currency cash flows of certain sale
arrangements resulting from changes in the exchange rate, from time to time we have
entered into forward contracts to hedge portions of our forecasted revenue and unbilled
accounts receivable denominated in foreign currencies. 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.

On
October 1, 2006, we changed our functional currency from the U.S. dollar to NIS. Changes
in the fair value of the forward contracts from October 1, 2006 were charged to financial
expenses. We recorded $915,000, $666,000 and $291,000 as financial expenses related to
forward contracts transactions in 2006, 2007 and 2008, respectively.

31

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Fair value of financial
instruments

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

| |  | the
carrying amounts of cash and cash equivalents, marketable securities, short-term bank
deposits, trade receivables, unbilled accounts receivable, restricted deposits,
short-term bank credit and trade payables approximate their fair value due to the
short-term maturity of such instruments.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
carrying amount of our long-term trade receivables and long-term bank deposits
approximate their fair value. The fair value was estimated using discounted cash flows
analysis, based on our investment rates for similar types of investment arrangements.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
carrying amounts of our long-term bank debt are estimated by discounting the future cash
flows using current interest rates for loans of similar terms and maturities. As of
December 31, 2008, the fair value of our long-term borrowings was approximately $3.0
million, compared to the carrying amount of approximately $3.1 million.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.

# Results of Operations

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

| |                                                    | Year Ended December 31,
| | -------------------------------------------------- | -----------------------
|
|
|
|
| | Revenues                                           |                        
| | Cost of revenues                                   |                        
| |                                                    |                        
| | Gross profit                                       |                        
| |                                                    |                        
| | Operating expenses:                                |                        
| | Research and development, net                      |                        
| | Selling and marketing, net                         |                        
| | General and administrative                         |                        
| | Impairment of goodwill and other intangible assets |                        
| | Post employment and termination benefits           |                        
| | Operating income (loss)                            |                        
| | Financial expenses, net                            |                        
| | Income (loss) before income taxes                  |                        
| | Income taxes                                       |                        
| |                                                    |                        
| | Income (loss) from continuing operations           |                        
| | Income (loss) from discontinued operations, net    |                        
| |                                                    |                        
| | Net income (loss)                                  |                        
| |                                                    |                        
| |                                                    |                        

# Year Ended December 31,
2008 Compared with Year Ended December 31, 2007

Revenues.           Revenues
decreased by 2.8% from $72.4 million in the year ended December 31,           2007 to
$70.4 million in the year ended December 31, 2008. Revenues from           sales of
perimeter systems decreased by 6.1% from $43.8 million in 2007 to $41.1           million
in 2008, primarily due to a reduction in sales in Israel and the United           States
as a result of the global economic slowdown and reduced spending in the           U.S.
market. Revenues from security turnkey projects increased by 2.9% from           $28.2
million in 2007 to $29.0 million in 2008. The increase is primarily
          attributable to revenues generated by our European integration subsidiary that
          was acquired in September 2007. This increase was offset in part by the
          cancellation and postponement of certain projects in Latin America. Other
          revenues (mostly service revenues and revenues derived from newly developed
          products) decreased by 41% from $427,000 in the year ended December 31,
          2007 to $252,000 in 2008. As revenues attributable to our European subsidiary
          are now recognized in accordance with the completed-contracts accounting
method,           we are unable to provide a projection for our revenues in 2009.

32

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Cost
of revenues.Cost of revenues increased by 13.1% from $43.5 million in the year ended
December 31, 2007 to $49.2 million in the year ended December 31, 2008. The increase
was primarily due to inventory write-off of $2.0 million in 2008 following the
cancellation of a project in Latin America and the write-off of certain products and
equipment associated with our North American research and development and manufacturing
activities, compared to an inventory write-off $646,000 in 2007. In addition, our cost of
revenues were adversely impacted by the appreciation of the NIS against the U.S. dollar in
2008, which increased the U.S. dollar value of our NIS denominated expenses by 12.8%.
Following its acquisition in September 2007, our new European subsidiary also contributed
to the increase in our cost of revenues in 2008. The gross margin of our other
subsidiaries was adversely affected by a decrease in their revenues, while their cost of
revenues decreased by a smaller percentage due to fixed costs. In 2008, our cost of
revenues also include a loss provision attributable to two strategic projects that had a
negative gross margin. Cost of revenues as a percentage of revenues increased from 60.1%
in 2007 to 69. 9% in 2008, primarily as our new European subsidiary was responsible in
2008 for a greater portion of total revenues than in 2007, while its gross margin is
relatively low. Our European subsidiarys gross margin was adversely affected in 2008
by a 10% penalty provision netted from its revenues. Our cost of revenues as a percentage
of revenues was also adversely impacted by the appreciation of the NIS against the U.S.
dollar in 2008, as the percentage of our cost of revenues denominated in NIS is higher
than the percentage of revenues denominated in NIS. As expenses attributable to our
European subsidiary are recognized in accordance with the completed-contracts accounting
method, we are unable to provide a projection for our cost of revenues in 2009.

Research
and development expenses, net. Research and development expenses, net increased by
7.5% from $5.8million for the year ended December 31, 2007, to $6.2 million
for the year ended December 31, 2008. The increase in research and development
expenses is primarily attributable to the appreciation of the NIS against the U.S. dollar
in 2008 that increased the U.S. dollar value of our NIS denominated expenses by 12.8%. In
addition, we invested additional funds in the development and further improvement of our
products in 2008, mainly the Fortis integrated command and control system. This increase
was offset in part by a decrease in the number of our U.S. subsidiarys research and
development staff and by an investment tax credit recorded by our Canadian subsidiary.
Research and development expenses, net amounted to 8.0% of revenues in 2007, compared to
8.8% in 2008. The research and development expenses of our Canadian subsidiary are net of
investment tax credits, which totaled $160,000 in 2007 and $234,000 in 2008. We anticipate
that our research and development expenses will not materially change in 2009.

Selling
and marketing expenses, net.Selling and marketing expenses, net increased by 32.9%
from $12.9 million for the year ended December 31, 2007 to $17.2 million for the year
ended December 31, 2008. The increase in selling and marketing expenses in 2008 was
primarily due to the consolidation of our new European subsidiary as of September 2007. In
addition, as a result of an increase in our European subsidiarys revenues in 2008,
the amortization of customer related intangible assets recorded in 2008 was higher than
the amortization of customer related intangible assets recorded in 2007. Sales commission
also increased in 2008 due to a different mix of revenues recorded in 2008 compared to
2007. The increase in selling and marketing expenses is also attributable to the
appreciation of the NIS against the U.S. dollar in 2008, which increased the U.S. dollar
value of our NIS denominated expenses by 12.8%. Selling and marketing expenses, net
amounted to 17.9% and 24.4% of revenues in 2007 and 2008, respectively.

General
and administrative expenses. General and administrative expenses increased from $6.6
million for the year ended December 31, 2007 to $10.9 million for the year ended December
31, 2008, an increase of 66.0%. The increase in general and administrative expenses in
2008 was primarily due to an increase in our allowance for doubtful accounts of
approximately $1.3 million as a result of the recent global economic downturn, which had
an adverse affect on the liquidity of some of our customers. In addition, we recorded a
provision of $550,000 related to a loan granted to a third party following our
determination that the full amount of the loan will not be repaid. In 2008, costs
associated with our compliance with the requirements of the Sarbanes-Oxley Act of 2002
(including the implementation of internal controls) and other audit expenses increased by
approximately $600,000. The increase in general and administrative expenses is also
attributable to the appreciation of the NIS against the U.S. dollar in 2008 that increased
the U.S. dollar value of our NIS denominated expenses by 12.8%. General and administrative
expenses amounted to 9.1% of revenues in 2007 compared to 15.5% in 2008.

33

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Impairment
of goodwill and other intangible assets. In 2008, following our annual impairment test
of goodwill and long lived assets, we determined that the fair value of our European
subsidiary acquired in September 2007 had decreased and that as a result, goodwill in the
amount of $8.4 million (including $3.3 million attributable to amounts prepaid on account
of future earn-out payments) had been impaired. As a result, for the year ended December
31, 2008, we recorded a non-cash goodwill impairment charge of $8.4 million. In addition,
we determined that $1.7 million of intangible assets attributable to customers of our
European subsidiary had been impaired, and as a result, we recorded an impairment charge
of $1.7 million. Following the 2008 annual impairment test, we also determined that the
fair value of our U.S. subsidiary had significantly declined and that as a result,
goodwill in the amount of $2.4 million attributable to the U.S. subsidiary had been
impaired. Impairment of other intangible assets amounted to approximately $350,000 in 2008
attributable to the write-off of certain know-how. We did not record any impairment of
goodwill and other intangible assets for the year ended December 31, 2007.

Post
employment and termination benefits. For the year ended December 31, 2008, we recorded
a post employment and termination benefits expense of $2.6 million, or 3.7% of our total
revenues, related to benefits payable to our former president and chief executive officer
and other senior employees in connection with their retirement from their respective
offices. For the year ended December 31, 2007, we recorded a post employment and
termination benefits expense of $904,000, or 1.2% of our total revenues, related to
benefits payable to the former chairman of our board of directors in connection with his
retirement.

Operating
income (loss). We had operating income of $2.7 million for the year ended December 31,
2007 compared to an operating loss of $28.6 million for the year ended December 31,
2008. The operating income (loss) of our three business segments for the years ended
December 31, 2007 and 2008 are as follows:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|Eliminations       |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

The
operating income of our perimeter products segment decreased from $2.4 million for the
year ended December 31, 2007 to an operating loss of $9.1 million for the year ended
December 31, 2008, primarily as a result of the decrease in revenues of this segment,
compared with a smaller decrease in cost of revenues due to the fixed-cost portion of our
expenses. The decrease in 2008 is also due to a $2.8 million impairment of goodwill and
other intangible assets charge, an increase in doubtful debt expenses and the appreciation
of the NIS against the U.S. dollar in 2008, which increased our NIS denominated expenses
by 12.8%. The operating income of our turnkey projects segment decreased from $506,000 in
the year ended December 31, 2007 to an operating loss of $19.5 million in the year ended
December 31, 2008, primarily as a result of a $10.1 million impairment of goodwill and
customer related intangible assets charge attributable to our European subsidiary acquired
in September 2007. In addition, we recorded a $2.5 million provision for penalties
attributable to a project of our new European subsidiary. In 2008, we also recorded a loss
provision attributable to two strategic projects that had a negative gross margin. The
operating results from other operations improved from an operating loss of $193,000 for
the year ended December 31, 2007 to operating income of $7,000 for the year ended December
31, 2008.

34

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---

Financial
expenses, net. Financial expenses, net, decreased from $2.1 million for the year ended
December 31, 2007 to $2.0 million for the year ended December 31, 2008, a
decrease of 6.1%. The decrease was primarily due to a decrease in interest expenses, net,
recorded on long and short-term debt, a decrease in forward contract losses and a decrease
in foreign exchange losses compared with 2007. The decrease was offset in part by a loss
of $955,000 attributable to our investments in marketable securities.

Income
taxes.We recorded an income tax expense of $373,000 for the year ended
December 31, 2007 compared to an income tax expense of $1.6 million for the year ended
December 31, 2008, primarily as a result of an increase in the valuation allowance that we
recorded with respect to our carryforward tax losses in 2008. In 2008, we recorded a full
valuation allowance with respect to our carryforward tax losses compared with a partial
allowance recorded in 2007, due to the uncertainty of their future realization. The
increase was offset in part by a decrease in tax expenses with respect to prior years.

# Year Ended December 31,
2007 Compared with Year Ended December 31, 2006

Revenues.           Revenues
increased by 13.8% from $63.6 million in the year ended December 31,           2006 to
$72.4 million in the year ended December 31, 2007. Revenues from           sales of
perimeter systems decreased by 6.1% from $47.2 million in 2006 to $43.8           million
in 2007, a decrease of 7.2%, primarily as a result of a decrease in           orders from
the Israeli MOD, which was partly offset by increased orders from           clients
outside of Israel. Revenues from security turnkey projects increased by           74.2%
from $16.2 million in 2006 to $28.2 million in 2007, primarily due to a           $5.7
million project performed for the Israeli government and the acquisition of           a
European integration company in September 2007. Other revenues, mainly from
          services for screening pallets and newly developed products, increased by 72.9%
          from $247,000 in the year ended December 31, 2006 to $427,000 in the year
          ended December 31, 2007.

Cost
of revenues. Cost of revenues increased by 16.8% from $37.2 million in the year ended
December 31, 2006 to $43.5 million in the year ended December 31, 2007, primarily as
a result of the increase in revenues. Cost of revenues as a percentage of revenues
increased from 58.5% in 2006 to 60.1% in 2007, primarily as a result of the increase in
the turnkey projects segment of our business, which has a lower profit margin. In
addition, we recorded a loss provision for one of the projects performed for the Israeli
government. In our perimeter segment, our cost of sales was adversely affected by an
increase in production costs.

Research
and development expenses, net. Research and development expenses, net increased from
$5.4 million for the year ended December 31, 2006, to $5.8 million for the year ended
December 31, 2007, an increase of 7.2%. The increase in research and development expenses
is primarily attributable to the appreciation of the NIS and Canadian dollar against the
U.S. dollar in 2007, which adversely affected research and development expenses
denominated in such currencies, and to bonuses paid to employees in 2007. Research and
development expenses, net amounted to 8.5% of revenues in 2006, compared to 8.0% in 2007.
The research and development expenses of our Canadian subsidiary are net of investment tax
credits, which totaled $162,000 in 2006 and $160,000 in 2007.

Selling
and marketing expenses, net.Selling and marketing expenses, increased from $11.6
million for the year ended December 31, 2006 to $12.9 million for the year ended December
31, 2007, an increase of 11.4%. The increase in selling and marketing expenses in 2007 was
primarily due to the amortization of customer related assets attributable to the
acquisition of the European integration company in September 2007. Selling and marketing
expenses amounted to 18.2% and 17.9% of revenues in each of 2006 and 2007, respectively.

General
and administrative expenses. General and administrative expenses increased from $5.5
million for the year ended December 31, 2006 to $6.6 million for the year ended
December 31, 2007, an increase of 18.3%. The increase ingeneral and
administrative expenses was due to expenses associated with our compliance with the
requirements of the Sarbanes-Oxley Act, including the implementation of internal
controlsover financial reporting, and an increase in salaries and legal expenses.
General and administrative expenses amounted to 8.7% of revenues in 2006 compared to 9.1%
in 2007.

35

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Impairment
of goodwill and other intangible assets.We did not record any impairment of
goodwill and other intangible assets for the years ended December 31, 2006 and 2007.

Post
employment and termination benefits. For the year ended December 31, 2007, we recorded
a post employment and termination benefits expense of $904,000, or 1.2% of our total
revenues, related to benefits payable to the former chairman of our board of directors in
connection with his retirement from such office. We did not record any post employment and
termination benefits expense for the year ended December 31, 2006.

Operating
income (loss). Our operating income declined from $3.8 million for the year ended
December 31, 2006 to $2.7 million for the year ended December 31, 2007. The operating
income (loss) of our three business segments for the years ended December 31, 2006 and
2007 are as follows:

|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Perimeter products |                        
|Turnkey projects   |                        
|Other              |                        
|Eliminations       |                        
|                   |                        
|Total              |                        
|                   |                        
|                   |                        

The
operating income of our perimeter products segment decreased from $3.1 million in the year
ended December 31, 2006 to $2.4 million in the year ended December 31, 2007, primarily as
a result of the increase in production costs and the depreciation of the U.S. dollar
against the NIS and the Canadian dollar, which adversely affected the U.S. dollar of our
revenues denominated in such currencies. The operating results for our turnkey projects
segment declined from an operating income of $935,000 in the year ended December 31, 2006
to operating income of $506,000 in the year ended December 31, 2007, primarily as a result
of a loss incurred with respect to one of our major projects and the amortization of the
customer related assets attributable to the acquisition of the European integration
company in September 2007. The operating loss from our other operations increased from
$138,000 in the year ended December 31, 2006 to $193,000 in the year ended December 31,
2007.

Financial
expenses, net. Financial expenses, net increased from $864,000 for the year ended
December 31, 2006 to $2.1 million for the year ended December 31, 2007, an increase of
147.3%. Our financial expenses increased by $1.3 million, mainly due to the depreciation
of the U.S. dollar against the NIS and the Canadian dollar, which caused an increase of
foreign exchange losses, net of $1.1 million. In addition, interest on short-term bank
credits increased by $648,000 due to the higher level of short-term loans incurred in
2007, which was offset in part by a decease in forward contracts loss of $249,000.

Income
taxes. We recorded income tax expenses of $943,000 for the year ended December 31,
2006 compared to income tax expenses of $373,000 for the year ended December 31, 2007. The
decrease is primarily as a result of the decrease in our income before taxes. The
effective tax rate increased to 65.6% for 2007 compared to 31.7% in 2006 due to the fact
that we recorded a valuation allowance on losses of $765,000, as a result of the low
likelihood that our deferred tax assets will be recovered from future taxable income.

36

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# Quarterly Results of
Operations

Our
recently acquired European subsidiary is engaged in turn-key projects in Africa. These
projects are executed with the assistance of a local subcontractor. Due to lack of
managerial and financial skills of the subsidiarys employees and to limited physical
access to these projects sites, the European subsidiary encountered difficulties in the
evaluation of the operating results of these projects during their respective execution
periods, as well as in the measurement of the expected costs and resources that will be
necessary to complete them. Insufficient managerial oversight by the local subcontractor
created additional burdens on the subsidiarys management, affecting its ability to
complete these projects. During the fourth quarter of 2008, management concluded that the
projects in Africa are not typical compared to our other projects and identified inherent
hazards related to these projects. As a result, management decided to change the
accounting method applied to these projects to the completed-contracts method and to
revise the results of operations previously reported for the first three quarters of 2008.

The
following tables set forth certain unaudited quarterly consolidated statements of income
data for the two years ended December 31, 2008, as revised, as well as the percentage of
our revenues represented by each item. We prepare our unaudited quarterly consolidated
financial statements on the same basis as our audited annual consolidated financial
statements included elsewhere in this annual report and include all adjustments
(consisting only of normal recurring adjustments) that we consider necessary for a fair
presentation of such information. The operating results for any quarter are not
necessarily indicative of results for any future periods. You should read this information
in conjunction with our consolidated financial statements, including the related notes,
appearing in Item 18  Financial Statements.

|                                   | Three months ended
|---------------------------------- | ------------------
|
|
|
|
|Revenues                           |                   
|Cost of revenues                   |                   
|                                   |                   
|Gross profit                       |                   
|                                   |                   
|Operating expenses:                |                   
|Research and development, net      |                   
|Selling and marketing, net         |                   
|General and administrative         |                   
|Impairment of goodwill and other   |                   
|intangible assets                  |                   
|Post employment and                |                   
|termination benefits               |                   
|                                   |                   
|Total operating expenses           |                   
|                                   |                   
|Operating income (loss)            |                   
|Financial expenses, net            |                   
|                                   |                   
|Income (loss) before income taxes  |                   
|Income taxes (tax benefit)         |                   
|                                   |                   
|Income (loss) from continuing      |                   
|operations                         |                   
|Loss from discontinued operations, |                   
|net                                |                   
|                                   |                   
|Net income (loss)                  |                   
|                                   |                   

37

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|                                    | Three months ended
|----------------------------------- | ------------------
|
|
|
|
|
|Revenues                            |                   
|Cost of revenues                    |                   
|                                    |                   
|Gross profit                        |                   
|                                    |                   
|Operating expenses:                 |                   
|Research and development, net       |                   
|Selling and marketing, net          |                   
|General and administrative          |                   
|Impairment of goodwill and other    |                   
|intangible assets                   |                   
|Post employment and                 |                   
|termination benefits                |                   
|                                    |                   
|Total operating expenses            |                   
|                                    |                   
|Operating income (loss)             |                   
|Financial expenses, net             |                   
|                                    |                   
|Income (loss) before income taxes   |                   
|Income taxes  (tax benefit)         |                   
|                                    |                   
|Income (loss) from continuing       |                   
|operations                          |                   
|Loss  from discontinued operations, |                   
|net                                 |                   
|                                    |                   
|Net income (loss)                   |                   
|                                    |                   
|                                    |                   

# Seasonality

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

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

| |  | due
to weather and other conditions, payments are often postponed from the first quarter to
subsequent                   quarters.
| | - | ----------------------------------------------------------------------------------------------------------------------------------

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

# Impact of Inflation and
Currency Fluctuations on Results of Operations, Liabilities and Assets

We
sell most of our products in North America, Europe and Israel. Our financial results,
which are reported in U.S. dollars, are affected by changes in foreign currency. Our
revenues are primarily denominated in U.S. dollars, Euros and NIS, while a portion of our
expenses, primarily labor expenses, is incurred in NIS and Canadian Dollars. Additionally,
certain assets, especially trade receivables, as well as part of our liabilities are
denominated in NIS. As a result, fluctuations in rates of exchange between the U.S. dollar
and non- U.S. dollar currencies may affect our operating results and financial condition.
The dollar cost of our operations in Israel may be adversely affected by the appreciation
of the NIS against the U.S. dollar. In addition, the value of our non-U.S. dollar revenues
could be adversely affected by the depreciation of the U.S. dollar against such
currencies.

The
appreciation of the NIS in relation to the U.S. dollar has the effect of increasing the
U.S. dollar value of any unlinked assets and the U.S. dollar amounts of any unlinked
liabilities and increasing the U.S. dollar value of revenues and expenses denominated in
other currencies. Conversely, the depreciation of the NIS in relation to the U.S. dollar
has the effect of reducing the U.S. dollar value of any of our liabilities which are
payable in NIS (unless such costs or payables are linked to the U.S. dollar). Such
depreciation also has the effect of decreasing the U.S. dollar value of any asset that is
denominated in NIS or receivables payable in NIS (unless such receivables are linked to
the U.S. dollar). In addition, the U.S. dollar value of revenues and expenses denominated
in NIS would increase. Because foreign currency exchange rates fluctuate continuously,
exchange rate fluctuations, may have an impact on our profitability and period-to-period
comparisons of our results. The effects of foreign currency re-measurements are reported
in our consolidated financial statements in current operations.

38

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The
following table presents information about the rate of inflation in Israel, the rate of
depreciation or appreciation of the NIS against the U.S. dollar, and the rate of inflation
of Israel adjusted for the devaluation:

|Year ended
December 31, | Israeli inflation
rate % | NIS depreciation
(appreciation)
rate % | Israeli inflation
adjusted for devaluation
(appreciation) %
|----------------------- | ------------------------ | -------------------------------------- | -----------------------------------------------------------
|
|
|
|
|2004                    |                          |                                        |                                                            
|2005                    |                          |                                        |                                                            
|2006                    |                          |                                        |                                                            
|2007                    |                          |                                        |                                                            
|2008                    |                          |                                        |                                                            

In
addition, the U.S. dollar cost of our operations in Canada is influenced by the exchange
rate between the U.S. dollar and the Canadian dollar. In 2008, the Canadian dollar
depreciated against the U.S. dollar by approximately 19.7%, while in 2007 and 2006, the
Canadian dollar appreciated against the U.S. dollar by 18.4% and 0.4%, respectively.

For
the year ended December 31, 2006, we recorded foreign currency exchange gains, net of
$276,000, while we recorded foreign currency exchange losses, net of $792,000 and $246,000
for the years ended December 31, 2007 and 2008, respectively. We cannot assure you that in
the future our results of operations may not be materially adversely affected by currency
fluctuations.

To
manage this risk, from time to time, we have entered into forward exchange contracts to
hedge some of our foreign currency exposure relating to revenue and unbilled accounts
receivable denominated in foreign currencies. We have designated the forward instruments
as cash flow hedges for accounting purposes. For derivative instruments designated as cash
flow hedges (i.e., hedging the exposure to variability in expected future cash flows that
is attributable to a particular risk), the effective portion of the gain or loss on the
derivative instrument is reported as a component of other comprehensive income and
reclassified into earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged transaction affects
earning.

On
October 1, 2006, we changed our functional currency from the U.S. dollar to NIS. Changes
in the fair value of the forward exchange contracts from October 1, 2006 are charged to
financial expenses. We recorded $915,000, $666,000 and $291,000 of financial expenses
attributable to forward exchange contracts transactions for the year ended December 31,
2006, 2007 and 2008, respectively.

# Conditions in Israel

We
are incorporated under the laws of, and our principal executive offices and manufacturing
and research and development facilities are located in, the State of Israel. See Item 3D
Key Information  Risk Factors  Risks Relating to Our Location in
Israel for a description of governmental, economic, fiscal, monetary or political
polices or factors that have materially affected or could materially affect our
operations.

# Effective Corporate Tax
Rate

Israeli
companies are generally subject to income tax on their worldwide taxable income. The
applicable rate for 2008 was 27%, which was reduced to 26% in 2009, and will be further
reduced to 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
Investments 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 Investments 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 depending on our compliance 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
Investments Law as a company in which more than 25% of its shareholders are non-Israeli
residents. Pursuant to the Investments 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).

39

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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, 2008, we had a deferred tax asset of $269,000 attributable to our
subsidiaries and had estimated total available carry forward tax losses of $14.9 million
to offset against future taxable income. We have recorded a full valuation allowance over
such carryforward tax losses due to the uncertainty of the deferred tax asset realization.
As of December 31, 2008, our subsidiaries had estimated total available carryforward
tax losses of $9.1 million to offset against future taxable income, which may be used as
an offset against future taxable income for periods ranging between 13-20 years. As of
December 31, 2008, we recorded a valuation allowance for most of our subsidiaries
carryforward tax losses 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 tax law provisions. The annual limitation may result in the expiration of
net operating losses before utilization.

In
December 2007, we finalized with the Israeli Tax Authority our tax assessments with
respect to the years 2001 to 2004.

# Recently Issued
Accounting Standards

In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations,or SFAS 141R. SFAS 141R establishes principles and
requirements for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any non controlling interest in the
acquired and the goodwill acquired. SFAS 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the business
combination. SFAS 141R is effective for fiscal years beginning after
December 15, 2008 and early adoption is prohibited. We believe that the impact of
SFAS 141R on our consolidated results of operations and financial condition will
depend on the nature and size of acquisitions, if any, subsequent to the effective date.

In
April 2008, the FASB issued FASB Staff Position, or FSP, FAS 142-3,
Determination of the Useful Life of Intangible Assets,or FSP
FAS 142-3. FSP FAS 142-3 amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under FASB SFAS No. 142, Goodwill and Other
Intangible Assets. FSP FAS 142-3 is effective for fiscal years beginning
after December 15, 2008 and early adoption is prohibited. We believe that the
adoption of FPS FAS 142-3 will not have impact on our consolidated financial
statements.

In
October 2008, the FASB issued FSP No.132 (R)-a, Employers Disclosures about
Pensions and Other Postretirement Benefits, to require that an employer disclose
the following information about the fair value of plan assets: 1) the level within the
fair value hierarchy in which fair value measurements of plan assets fall; 2) information
about the inputs and valuation techniques used to measure the fair value of plan assets;
and 3) a reconciliation of beginning and ending balances for fair value measurements of
plan assets using significant unobservable inputs.  The FSP will be effective
for fiscal years ending after December 15, 2009, with early application permitted.
Application of the FSP would not be required for earlier periods that are presented for
comparative purposes.  We are currently evaluating the potential impact of
adopting this FSP on our disclosures in the financial statements.

40

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In
November 2008, the Emerging Issues Task Force, or EITF, issued EITF Issue No. 08-7,
Defensive Intangible Assets, or EITF 08-7, which requires an acquiring
entity to account defensive intangible assets as a separate unit of accounting. Defensive
intangible assets should not be included as part of the cost of the acquirers
existing intangible assets because the defensive intangible assets are separately
identifiable. Defensive intangible assets must be recognized at fair value in accordance
with SFAS 141(R) and SFAS 157. EITF 08-7 will be effective for the reporting period
beginning after December 15, 2008. We do not expect a material impact on our consolidated
financial statements from the adoption of EITF 08-7.

In
April 2009, the FASB issued FSP No. FAS 115-2 and SFAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments, or the FSP No. 115-2. FSP No.
115-2 is intended to provide greater clarity to investors about the credit and noncredit
component of an other-than-temporary impairment event and to more effectively communicate
when an other-than-temporary impairment event has occurred. FSP No. 115-2 applies to fixed
maturity securities only and requires separate display of losses related to credit
deterioration and losses related to other market factors. When an entity does not intend
to sell the security and it is more likely than not that an entity will not have to sell
the security before recovery of its cost basis, it must recognize the credit component of
an other-than-temporary impairment in earnings and the remaining portion in other
comprehensive income. Upon adoption of the FSP No. 115-2, an entity will be required to
record a cumulative-effect adjustment as of the beginning of the period of adoption to
reclassify the noncredit component of a previously recognized other-than-temporary
impairment from retained earnings to accumulated other comprehensive income. The FSP will
be effective for us for the quarter ending June 30, 2009. We are currently evaluating the
impact of adopting the FSP.

In
April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly, or FSP 157-4. FSP 157-4 provides
additional authoritative guidance to assist both issuers and users of financial statements
in determining whether a market is active or inactive, and whether a transaction is
distressed. FSP 157-4 will be effective for us for the quarter ending June 30, 2009. We do
not expect the adoption of FSP 157-4 to have a material impact on our consolidated
financial position and results of operations.

|B. | Liquidity
and Capital Resources
|-- | -------------------------------

# General

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 and in April 2005, we raised an additional $14.9 million from a
follow-on offering of 1,700,000 ordinary shares. The proceeds from these offerings
together with cash flow from operations and our credit facilities are our main sources of
working capital.

Our
working capital decreased from $41.5 million at December 31, 2007 to $16.4 million at
December 31, 2008. Cash and cash equivalents amounted to $9.2 million at December 31,
2007 compared to $16.8 million at December 31, 2008. Short-term and long-term bank
deposits, marketable securities, restricted bank deposits and escrow deposits amounted to
$26.9 million at December 31, 2007 compared to $8.1 million at December 31, 2008. Our cash
and cash equivalents, short and long-term bank deposits and marketable securities are held
mainly in U.S. dollars, Euros and NIS.

41

---

---

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 flows and our credit facilities. We believe that
our current cash and cash equivalents, including bank deposits, marketable securities and
our expected cash flows from operations in 2009 will be sufficient to meet our cash
requirements through 2009. However, our liquidity could be negatively affected by a
decrease in demand for our products, including the impact of potential reductions in
customer purchases that may result from the current general economic downturn.

# Cash Flows

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

|                                                             | Year ended December 31,
|------------------------------------------------------------ | -----------------------
|
|
|
|
|Net cash provided by (used in) continuing operations         |                        
|Net cash provided by (used in) discontinued operations       |                        
|                                                             |                        
|Net cash provided by (used in) operating activities          |                        
|Net cash provided by (used in) investing activities          |                        
|Net cash provided by financing activities                    |                        
|Effect of exchange rate changes on cash and cash equivalents |                        
|Increase (decrease) in cash and cash equivalents             |                        
|Cash and cash equivalents at the beginning of the year       |                        
|                                                             |                        
|Cash and cash equivalents at the end of the year             |                        
|                                                             |                        
|                                                             |                        

Net
cash used in operating activities was approximately $1.4 million in the year ended
December 31, 2006 compared to $9.9 million net cash provided by operating activities
in the year ended December 31, 2007 and $0.7 million net cash provided by operating
activities in the year ended December 31, 2008. Net cash used in operating activities in
the year ended December 31, 2006 was primarily attributable to an increase in trade
receivables of $4.4 million, an increase in inventories of $2.7 million, a return of $2.8
million of customer advances and a decrease in trade payables of $666,000, which was
offset in part by net income of $810,000, depreciation and amortization of $1.2 million, a
decrease in unbilled accounts receivable of $3.5 million, an increase in other accounts
payable and accrued expenses of $717,000 and a $437,000 decrease in other accounts
receivable and prepaid expenses. Net cash provided by operating activities in the year
ended December 31, 2007 was primarily attributable to an increase in customer advances of
$10.4 million, an increase of $4.3 million and $1.8 million in trade receivables and
unbilled accounts receivable, respectively, an increase of $1.8 million in accrued
interest on marketable securities and short-term and long-term bank deposits and
depreciation and amortization of $2.1 million, which was offset in part by a decrease in
trade payables of $6.3 million, a decrease in other accounts payable and accrued expenses
of $1.8 million, an increase in long-term trade receivables of $1.8 million and a gain
from discontinued operations of $1.7 million. Net cash provided by operating activities in
the year ended December 31, 2008 was primarily attributable to a $12.9 million non-cash
goodwill and other intangible assets impairment charge, $ 3.1 million depreciation and
amortization expenses, a decrease in trade receivable of $10.6 million, a decrease in
inventories of $ 8.9 million and an increase of $6.5 million, $7.6 million and $ 3.4
million in accounts payables, cost incurred on long-term contracts and unbilled other
payables, respectively, and a decrease of $2.1 million in accrued interest and exchange
differences on marketable securities and short-term and long-term bank deposits, which was
offset in part by a decrease in customer advances of $9.3 million and an increase in
unbilled accounts receivables of $1.2 million.

Net
cash used in investing activities was approximately $5.2 million and $464,000 for the
years ended December 31, 2006 and 2007, respectively, compared to $6.6 million net cash
provided by investing activities in the year ended December 31, 2008. In the year ended
December 31, 2006, we purchased $906,000 of property and equipment, $8.2 million of
marketable securities, invested $622,000 in a long-term loan and purchased know-how and
patents for $148,000 with the proceeds from the sale of marketable securities of $5.2
million. In the year ended December 31, 2007, we acquired a European integration company
for $4.0 million and purchased $10.8 million of marketable securities, $4.4 million of
escrow deposits and $890,000 of property and equipment, which was offset by proceeds of
$8.5 million from the sale of the assets and business of a subsidiary, proceeds of $5.6
million from the sale of marketable securities and $5.7 million from the sale of
short-term bank deposits. In the year ended December 31, 2008, we had proceeds of $5.1
million from the sale of marketable securities and $11.1 million from the sale of
short-term bank deposits, which amounts were offset in part by purchases of $1.4 million,
$3.3 million and $2.0 million of short-term bank deposits, restricted bank deposits and
marketable securities, respectively. In addition, we purchased $1.7 million of property,
plant and equipment and $1.1 million of know-how and patents.

42

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---

In
the year ended December 31, 2006, net cash provided by financing activities of $1.7
million was primarily attributable to $3.2 million from proceeds of long-term loans that
we obtained to finance the costs incurred in connection with the cancellation of a project
in Eastern Europe and our receipt of $163,000 from the exercise of employee stock options,
which was offset in part by $1.4 million from short-term bank credits to finance the
operations of our video monitoring segment and the repayment of $306,000 of long-term bank
loans. In the year ended December 31, 2007, net cash used in financing activities of $5.5
million was primarily due to the repayment of $4.7 million of short-term bank credits and
repayment of $796,000 of long-term bank loans, which was offset in part by receipt of
$43,000 from the exercise of employee stock options.In the year ended December 31,
2008, net cash provided by financing activities of $2.7 million was primarily due to an
increase of $7.0 million in short-term bank credits, which was offset by the repayment of
$4.3 million of long-term bank loans.

We
had capital expenditures of approximately $906,000, $890,000 and $1.7 million in 2006,
2007 and 2008, respectively. These capital expenditures were principally for computers,
other machinery and equipmentand for expanding and renovating our facilities. We
estimate that our capital expenditures for 2009 will total approximately $1.7 million,
substantially all of which will relate to our perimeter security and project segments. We
expect to finance these expenditures primarily from our cash and cash equivalents,
operating cash flows and our credit facilities. However, the actual amount of our capital
expenditures will depend on a variety of factors, including general economic conditions,
changes in the demand for our products.

# 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., BNP
Paribas S,A totaling $46.1 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. Our loans under these credit lines are denominated in dollars and
NIS. As of December 31, 2008, we are not under any obligation to maintain financial ratios
or other terms in respect of our credit lines.

In
addition, our subsidiaries currently have credit lines with Bank Leumi USA, Royal Bank of
Canada, Commerz Bank, Leuitkircher Bank and Deutsche Bank, totaling $9.9 million in the
aggregate.

Our
Canadian subsidiary, which is primarily engaged in sale of perimeter products and turnkey
projects, has undertaken to maintain general covenants and the following financial ratios
and terms in respect of its outstanding credit lines: a quick ratio of not less than 1.25;
a ratio of total liabilities to tangible net worth of not greater than 0.75; and tangible
net worth of at least $9.0 million. As of December 31, 2008, our Canadian subsidiary was
in compliance with these ratios and terms.

As
of December 31, 2008, we had approximately $19.2 million available under our credit
lines. In addition, our subsidiaries had approximately $5.1 million available under their
credit lines. As of December 31, 2008, our outstanding balances under our credit
lines consisted of:

| |  | Short-term
NIS-denominated loans of approximately $23.2 million, bearing an average interest at a
rate                   of 4.25%;
| | - | ----------------------------------------------------------------------------------------------------------------------------------

| |  | Long-term
U.S. dollar-denominated loans of approximately $1.8 million, bearing an average interest
at a                   rate of 2.75%; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

| |  | Several
bank performance and advance payment guarantees totaling approximately $11.4 million, at
an annual cost of 0.5%-1%.
| | - | ---------------------------------------------------------------------------------------------------------------------------

43

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As
of December 31, 2008, our subsidiaries had $1.3 million in long-term loans primarily
relating to our perimeter security segment as follows:

| |  | $355,000
bearing interest at a fixed rate of 5.45%.  The loan is payable in 20 quarterly
installments of                   $47,200, commencing February 2006.  We have guaranteed
the full amount of this loan; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | $980,000
bearing interest at a fixed rate of 5.45%.  The loan is due in one installment in
                  November 2010.  We have guaranteed the full amount of this loan.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 past we have received royalty-bearing grants from the
OCS for certain of our research and development projects for perimeter security products.
We did not obtain any grants from the OCS for the years ended December 31, 2006, 2007 and
2008. 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 and ancillary services, up to
100% of the grants received, linked to the U.S. dollar. All grants received after January
1, 1999 also bear interest equal to the 12 month LIBOR rate. 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.

For
the years ended December 31, 2006, 2007 and 2008, we paid the OCS royalties in the amount
of $79,000, $143,000 and $125,000, respectively. These royalties related to sales of
perimeter security products and management security system. As of December 31, 2008, we
had a contingent obligation to pay royalties to the OCS in the amount of approximately
$1.37 million upon the successful sale of perimeter securityproducts developed
using research and development programs sponsored by the OCS.

The
Israeli Government, through the Fund for the Encouragement of Marketing Activities, or the
Fund, awarded us grants for overseas marketing expenses during the years 2001 to 2003. To
date, we have received an aggregate $253,000 in grants from the Fund. Under the terms of
the grants, we are obligated to pay certain royalties on the increase in export sales from
the year the grant was received and the following year, up to the amount of the grants we
received. During the years ended December 31, 2006, 2007 and 2008, we did not pay any
royalties. As of December 31, 2008, we had a remaining contingent obligation to the
Fund of $82,000.

# Investment Tax Credit

Our
Canadian and U.S subsidiaries are eligible for investment tax credits on their research
and development activities and on certain current and capital expenditures. For the years
ended December 31, 2006, 2007 and 2008, our Canadian subsidiary recognized $162,000,
$160,000 and $234,000, respectively, of investment tax credits as a reduction of research
and development expenses. In addition, as of December 31, 2008, our Canadian and U.S
subsidiaries had available investment tax credits of approximately $706,000 to reduce
future federal income taxes payable. These credits will expire in 2019 through 2028. See
also Item 4.B. Information on the CompanyBusiness OverviewResearch and
Development; Royalties.

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

In
recent years consolidation in the defense industry has affected competition resulting in
an increase in the relative size and resources of our competitors. We adapt to evolving
market conditions by adjusting our technology and business strategy. We also anticipate
increased competition in defense markets due to declining defense budgets in certain
countries. The recent financial developments worldwide may reduce defense spending.
However, we believe in our ability to compete on the basis of our technology and systems
development that offers customers overall solutions to technological and operational
needs.

44

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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.

As
of December 31,2008, our backlog amounted to approximately $60.9 million, of which
approximately $31.3 million is expected to be delivered by the end of 2009, $17.6 million
is expected to be delivered by the end of 2010 and $12.0 million is expected to be
delivered thereafter.

See
also discussion in Item 5A. Operating and Financial Review and Prospects 
Operating Results.

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

We
are not a party to any material off-balance sheet arrangements. In addition, we have no
unconsolidated special purpose financing or partnership entities that are likely to create
material contingent obligations.

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

The
following table summarizes our minimum contractual obligations and commercial commitments
as of December 31, 2008 and the effect we expect them to have on our liquidity and cash
flow in future periods.

|                                         | Payments due by period
|---------------------------------------- | ----------------------
|
|
|
|
|Long-term bank debt obligations          |                       
|Operating lease obligations              |                       
|Purchase obligations                     |                       
|Other long-term liabilities reflected on |                       
|our balance sheet under U.S. GAAP        |                       
|Total                                    |                       

In
addition, 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, 2008 and March
31, 2009 were $11.4 million and $12.3 million, respectively. We have not recorded any
liability for such amounts as we expect that our performance will be acceptable and to
date, no performance bank guarantees have been exercised against us except with respect to
our dispute relating to the project in Eastern Europe. See Item 8.A 
Consolidated Statements and Other Financial Information-Legal Proceedings.

45

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

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

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

|Name                  | Age | Position                                                           
|--------------------- | --- | -------------------------------------------------------------------
|
|
|
|
|Jacob Perry           | 65  | Chairman of the Board of Directors                                 
|Hagai Katz            | 58  | General Manager, Israel Division, Senior Vice President - Marketing
|                      |     | and Products and Chief Information Officer                         
|Asaf Even-Ezra        | 44  | Senior Vice President -Sales                                       
|Yehonatan Ben-Hamozeg | 50  | Senior Vice President - Product Development and Projects           
|Zev Morgensten        | 45  | Vice President - Finance, Chief Financial Officer and Secretary    
|                      |     |                                                                    
|Jacob Even-Ezra (1)   | 78  | Director                                                           
|Nathan Kirsh          | 78  | Director                                                           
|Shaul Kobrinsky(1)(2) | 57  | External Director                                                  
|Zeev Livne            | 65  | Director                                                           
|Jacob Nuss(2)         | 62  | Director                                                           
|Barry Stiefel         | 59  | Director                                                           
|Anat Winner (1)(2)    | 49  | External Director                                                  
|                      |     |                                                                    

---

|(1)
Member of our Investment Committee.(2)
Member of our Audit Committee.
|-------------------------------------------------------------------------

Messrs. Perry, Even-Ezra, Kirsh, Livne, Nuss and Steifel will serve as directors until
          our 2009 Annual General Meeting of Shareholders. Mr. Kobrinsky and Ms. Winner
          will serve as external directors pursuant to the provisions of the Israeli
          Companies Law for three-year terms until our 2010 annual general meeting of
          shareholders.

Mr. Jacob Even-Ezra is the father of Mr. Asaf Even-Ezra. There are no other family
          relationships among our directors and senior executives.

Effective
as of August 2, 2009, Mr. Eitan Livneh will assume the positions of President and chief
executive officer of our company.

Jacob
Perry has served as the chairman of our board of directors since January 2008. Prior
thereto, Mr. Perry served as the deputy chairman of our board of directors from 2006 and
has served as a director of our company since December 2002. From 1995 to December 2002,
Mr. Perry served as the President and chief executive of Cellcom Israel Ltd., one of
Israels leading cellular phone operator. Mr. Perry served 29 years with the Israeli
General Security Service, and served as its director from 1988 until 1995. Mr. Perry has
also served as a coordinator 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., Pinpoint Advanced
Corp., Inc., a blank check company traded in the United States, and Keren Mor, a real
estate fund. Mr. Perry serves as a director of Tamarind Technologies, Leadcom Integrated
Solutions Ltd., an Israeli public company that engages in construction infrastructure for
cellular communication, and New Kopel, an Israeli vehicle and car service group. Mr. Perry
holds a B.A. degree in Oriental Studies and History of the Jewish People from Tel-Aviv
University and completed the Advanced Management Program at Harvard Business School.

Hagai
Katz has served as our general manager, Israel division and corporate vice president
 marketing and products since January 2009. Prior to joining our company and from
2007, Mr. Katz served as the chief executive officer of Transtech Airport Solutions Ltd.
From 2004 to 2007 Mr. Katz served as the chief executive officer of UAV Tactical Systems
Ltd., based in the United Kingdom. Prior to that, Mr. Katz served in a number of leading
technology companies, including NICE Systems (NASDAQ: NICE), where he served in various
senior positions including chief operating officer and President of its video analytics
division. Mr. Katz holds a B.A. degree in Computer Sciences from the Technion 
Israel Institute of Technology and an M.Sc. degree in Business Engineering from the
Ben-Gurion University of the Negev.

46

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Asaf
Even-Ezra has served as our senior vice president  sales since December 2008 Mr.
Even-Ezra joined our company in 1995 and served as our vice president  Israel and
West European marketing from 1998 to July 2007 and as our executive vice president 
sales and marketing from July 2007 to December 2008. Mr. Even-Ezra holds a B.A. degree and
an M.B.A. degree in Business, both from the New York Institute of Technology.

Yehonatan
Ben-Hamozeghas served as our vice president  product development and projects
since January 2009. Mr. Ben Hamozeg joined our company in December 2002 and served as our
vice president  integrated systems development until January 2009. Before joining
our company, Mr. Ben Hamozeg served in the IDF for 24 years and retired as a Colonel. Mr.
Ben Hamozeg holds a B.A. degree in Economics and Statistics and an M.B.A. degree in
Business Management, both from Haifa University.

Zev
Morgenstenhas served as ourvice president  finance, chief financial
officer and secretary since April 2009. Prior to joining our company and from 1997, Mr.
Morgenstern served as the chief financial officer of Advanced Vision Technology Ltd., a
public company traded on the Frankfurt Stock Exchange, a world leading supplier of
automatic optical inspection and quality assurance systems for the printing industry. From
1994 to 1997, Mr. Morgenstern served as the finance manager of Precise Software Solutions,
a company listed on the NASDAQ stock exchange, headquartered in Boston, MA. From 1985 to
1994, Mr. Morgenstern served as a senior auditor at Braude & Co., a member firm of
KPMG International. Mr. Morgenstern holds a B.A. degree in Accounting and Economics from
Bar Ilan University in Israel and is a Certified Public Accountant (Israel).

Jacob
Even-Ezra has served as a director since 1984 and is a member of our investment
committee. From 1984 until December 2007, Mr. Even-Ezra served as the chairman of our
board of directors. From 1984 until 2006, Mr. Even-Ezra also served as our chief executive
officer, and from 1987 until 1990 he also served as our president. Mr. Even-Ezra is
currently a member of the Executive Council and the Management Committee of Tel Aviv
University. From 1985 to 1988, Mr. Even-Ezra also served as the chairman of the Israel
Export Institute. Mr. Even-Ezra holds a B.Sc. degree in Electrical Engineering from the
Technion  Israel Institute of Technology.

Nathan
Kirsh has served as a director since 1984. Mr. Kirsh is an independent investor. Mr.
Kirsh serves as one of the trustees of the Eurona Foundation, the beneficial owner of 100%
of the ordinary shares of our company that are held by Mira Mag Inc. Mr. Kirsh holds a
B.S. degree in Commerce from the University of Witwatersrand, Johannesburg, South Africa.

Barry
Stiefel, was appointed by our board of directors as a director inNovember
2008. Mr. Stiefel served as a director of one of our UK subsidiaries from 1986 to 1990.
Since 2001, Mr. Stiefel has served as a consultant for a variety of companies, including
PremediaLimited and its subsidiaries. From 1990 until 2001, Mr.
Stiefel was the chief executive officer of Meridian VAT Reclaim Group, which he founded.
Between 1985 and 1990, Mr. Stiefel served as consultant in the field of trade finance.
From 1981 to 1985, Mr. Stiefel served as finance director of Fisher Brothers Lumber
Company Limited, a South African company. Mr. Stiefel holds a B.Sc degree in Mathematics
and Chemistry and a B.A. degree in Accounting, both from the University of Witwatersrand
in South Africa. Mr. Stiefel is a chartered accountant in South Africa, and is registered
as an auditor (not in public practice) in the United Kingdom.

Zeev
Livnehas served as a director since July 2004. Mr. Livne has served asthe chairman of Livne Strategic Consultants Ltd.since 2001. Prior to that,Mr. Livne served in the IDF for 39 years and retired as a Major General. During his
long military career with the IDF, Mr. Livne served as the Defense Attaché to the
United States 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 Ltd., a private Israeli company. Mr.
Livne holds a B.A. degree in History from Tel Aviv University and an M.A. degree in
Geography from the University of Haifa.

47

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---

Shaul
Kobrinskyhas served as an external director since July 2004 and is the
chairman of our audit committee and a member of our investment committee. 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. Prior to that and from 1984, Mr. Kobrinsky served as
deputy managing director of Clal Industries Ltd., a holding and investment company. Mr. Kobrinsky
holds a B.A. degree in Economics from Tel Aviv University. Mr. Kobrinsky is a member of
the anti-trust court of the State of Israel.

Jacob
Nuss has served as a director since 1993 and is a member of our audit committee. Mr.
Nuss has served as the vice president  internal auditing of IAI since 2004, 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
directors of IAI. Mr. Nuss has served in various financial management capacities at IAI
since 1975. Mr. Nuss holds a B.A. degree in Economics and Business Management from Bar
Ilan University and an M.B.A. degree in Business from Tel Aviv University. Mr. Nuss holds
a certificate in internal auditing.

Anat
Winner has served as an external director since July 2004 and is a member of our audit
committee and our investment committee. Ms. Winner has been self employed as a business
advisor since July 2003. Ms. Winner also serves as a director of Internet Gold-Golden
Lines Ltd. (NASDAQ: IGLD) and 012 Smile Communications Ltd. (NASDAQ: SMLC). From October
2001 to May 2003, Ms. Winner served as chief executive officer and chief financial officer
of Israel News Ltd. From 1999 to October 2001, Ms. Winner served as chief financial
officer of DBS Satellite Services (1998) Ltd. (YES), an Israeli company that is engaged in
setting up and operating broadcasting satellite television television systems. From 1995
to 1998, Ms. Winner served as chief financial officer of Eurocom Cellular Communications
Ltd., an Israeli company that is engaged in importing and marketing cellular phones. From
1989 to 1995, Ms. Winner served in various finance positions, including chief financial
officer of the Seed Company (1939) Ltd. From 1984 to 1989 Ms. Winner served as a senior
audit manager with Ronel Stetner & Co., certified public accountants in Israel. Ms.
Winner holds a B.A. degree in Accounting and Economics from Haifa University and has been
a certified public accountant in Israel since 1987.

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

During
the year ended December 31, 2008, we paid an aggregate compensation to our executive
officers and directors as a group (consisting of 17 persons, of whom five retired
subsequent to December 31, 2008) of approximately $1.97 million. This amount does not
include certain consideration paid in connection with the retirement of one of our
directors. As of December 31, 2008, the aggregate amount set aside or accrued for pension,
retirement, recreation payments and vacation or similar benefits for our directors and
executive officers was approximately $3.8 million. In addition, we have provided
automobiles to our executive officers at our expense, and Mr. Jacob Even-Ezra, a director,
is reimbursed for the costs of a chauffeur.

As
of January 1, 2008, we pay Mr. Perry, the chairman of our board of directors, a monthly
payment of NIS 50,000 (approximately $13,000), which amount is linked to the Israeli
consumer price index and subject to a 10% annual increase, and he is also entitled to an
annual bonus based on our performance and customary social benefits.

From
January 1, 2008 until March 6, 2008, we paid our external directors and independent
directors (directors who are not employees of our company or officers or employees of any
entity that beneficially owns 5% or more of our ordinary shares) an annual fee (on a pro
rata basis) of $8,000 and a fee of $300 for each board or committee meeting that they
attended. Since March 6, 2008, we pay our external directors and such independent
directors an annual fee of NIS 59,100 (approximately $16,500) and a fee of NIS 2,200
(approximately $615) for each board or committee meeting that they attend. Such amounts
are linked to the Israeli consumer price index and are updated on a semi-annual basis and
accordingly, were adjusted to reflect changes in the Israeli consumer price index in
August 2008 and February 2009.

48

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As
of December 31, 2008, our directors and executive officers as a group, then consisting of
16 persons, held options to purchase an aggregate of 431,200 ordinary shares, having
exercise prices ranging from $6.12 to $13.00. Generally, the options vest over a two to
four years period. Of such options, options to purchase 52,500 ordinary shares
subsequently expired in January 2009, options to purchase 48,700 ordinary shares expire in
December 2010, options to purchase 30,000 ordinary shares expire in January, 2015 and
options to purchase 300,000 ordinary shares expire in three equal portions of 100,000
ordinary shares each in August 2013, 3014 and 2015, or earlier upon termination of
employment as an executive officer or service as a director of our company. As of June 30,
2009, our directors and executive officers as a group, then consisting of 12 persons, held
options to purchase an aggregate of 466,000 ordinary shares, having exercise prices
ranging from $4.09 to $8.56. Of such options, options to purchase 18,000 ordinary shares
expire in December 2010, options to purchase 300,000 ordinary shares expire in three equal
portions of 100,000 ordinary shares each in August 2013, 3014 and 2015, options to
purchase 98,000 ordinary shares expire in four equal portions of 24,500 ordinary shares
each in April 2013, 2014, 2015 and 2016, options to purchase 17,500 ordinary shares expire
in January 2014, options to purchase 11,250 ordinary shares expire in January 2015,
options to purchase 11,250 ordinary shares expire in January 2016 and options to purchase
10,000 ordinary shares expire in April 2016, or earlier upon termination of employment as
an executive officer or service as a director of our company. All of such options were
granted under our 2003 Stock Option Plan. See this Item 6E. Directors, Senior
Management and Employees  Share Ownership  Stock Option Plans.

We
follow Israeli law and practice, instead of the requirements of the NASDAQ Marketplace
Rules, with regard to the compensation of our chief executive office and other executive
officers. See Item 16G. Corporate Governance.

|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

Our
articles of association provide for a board of directors of not less than three and not
more than 11 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 external 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 external directors), may be
reelected upon completion of their term of office. Our annual general meetings of
shareholders are held at least once every calendar year, but not more than 15 months after
the last preceding annual general meeting. In the intervals between our annual general
meetings of shareholders, the board of directors may from time to time appoint a new
director to fill a casual vacancy or to add to their number, and any director so appointed
will remain in officer until our next annual general meeting of shareholders and may be
re-elected.

Under
the Israeli Companies Law, our board of directors is required to determine the minimum
number of directors who must have accounting and financial expertise, as such
term is defined in regulations promulgated under the Israeli Companies Law. Our board of
directors has determined that at least one director must have accounting and
financial expertise. 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 Item 16G. Corporate Governance.

49

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# External and Independent
Directors

External
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 external
directors. The Israeli Companies Law provides that a person may not be appointed as an
external director if the person, or the persons relative, partner, employer or an
entity under that persons control, has or had during the two years preceding the
date of appointment any affiliation with the company, or any entity controlling,
controlled by or under common control with the company. The term relative
means a spouse, sibling, parent, grandparent, child or child of spouse or spouse of any of
the above. In general, the term affiliation includes an employment
relationship, a business or professional relationship maintained on a regular basis,
control and service as an office holder. Regulations promulgated under the Israeli
Companies Law include certain additional relationships that would not be deemed an
affiliation with a company for the purpose of service as an external director.

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

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

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

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

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

Independent
Directors. In general, NASDAQ Marketplace Rules require that the board of directors of
a NASDAQ-listed company have a majority of independent directors and that its audit
committee have at least three members and be comprised only of independent directors, each
of whom satisfies the respective independence requirements of NASDAQ and the
Securities and Exchange Commission. However, foreign private issuers, such as our company,
may follow certain home country corporate governance practices instead of certain
requirements of the NASDAQ Marketplace Rules. On June 30, 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, under Israeli
law and practice we are required to appoint at least two external directors, within the
meaning of the Israeli Companies Law, to our board of directors. However, despite such
notification of non-compliance, we maintain a majority of independent directors. In
addition, in accordance with the rules of the Securities and Exchange Commission and
NASDAQ, we have the mandated three independent directors, as defined by the rules of the
Securities and Exchange Commission and NASDAQ, on our audit committee.

50

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Pursuant
to a recent amendment to the Israeli Companies Law, an Israeli company whose shares are
publicly traded may elect to adopt a provision in its articles of association pursuant to
which a majority of its board of directors will constitute individuals complying with
certain independence criteria prescribed by the Israeli Companies Law. We have not
included such a provision in our articles of association.

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

# Audit Committee

Under
the Israeli Companies Law, the board of directors of any public company must establish an
audit committee. The audit committee must consist of at least three directors and must
include all of the external directors. The audit committee may not include the chairman of
the board of directors; any director employed by the company or providing services to the
company on an ongoing basis; or a controlling shareholder or any of the controlling
shareholders relatives. The responsibilities of the audit committee include
identifying irregularities in the management of the companys business and 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 external directors are serving as members of
the audit committee and at least one of the external directors was present at the meeting
in which an approval was granted.

In
addition, the NASDAQ Marketplace Rules require us to establish an audit committee
comprised of at least three members, all of whom must be independent directors, each of
whom is financially literate and satisfies the respective independence
requirements of the Securities and Exchange Commission and NASDAQ and one of whom has
accounting or related financial management expertise at senior levels within a company.

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
Messrs. Shaul Kobrinsky and Jacob Nuss and Ms. Anat Winner. The audit committee meets at
least once each quarter. Our audit committee charter is available on our website at
www.magal-ssl.com.

# Investment Committee

Our
board of directors has established an investment committee, which is responsible for the
investment of our cash and our hedging transactions. The investment committee is currently
composed of Messrs. Jacob Even-Ezra and Shaul Kobrinsky and Ms. Winner,

51

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# Internal Auditor

Under
the Israeli Companies Law, the board of directors of a public company must appoint an
internal auditor nominated by the audit committee. The role of the internal auditor is to
examine whether the companys actions comply with the law, integrity and orderly
business practice. 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 Shapira, Certified Public Accountant (Israel)
is our internal auditor.

# Directors Service
Contracts

There
are no arrangements or understandings between us and any of our subsidiaries, on the one
hand, and any of our directors, on the other hand, providing for benefits upon termination
of their employment or service as directors of our company or any of our subsidiaries.

# Approval of Related
Party Transactions Under Israeli Law

Fiduciary Duties of
Office Holders

The
Israeli Companies Law codifies the fiduciary duties that office holders,
including directors and executive officers, owe to a company. An office holder
is defined in the Israeli Companies Law as a director, general manager, chief business
manager, deputy general manager, vice general manager, other manager directly subordinate
to the general manager or any other person assuming the responsibilities of any of the
foregoing positions without regard to such persons title. An office holders
fiduciary duties consist of a duty of care and a fiduciary duty. The duty of care requires
an office holder to act at a level of care that a reasonable office holder in the same
position would employ under the same circumstances. This includes the duty to utilize
reasonable means to obtain (i) information regarding the appropriateness of a given action
brought for his approval or performed by him by virtue of his position and (ii) all other
information of importance pertaining to the foregoing actions. The fiduciary duty includes
(i) avoiding any conflict of interest between the office holders position in the
company and any other position he holds or his personal affairs, (ii) avoiding any
competition with the companys business, (iii) avoiding exploiting any business
opportunity of the company in order to receive personal gain for the office holder or
others, and (iv) disclosing to the company any information or documents relating to the
companys affairs that the office holder has received due to his position as an
office holder.

Disclosure of Personal
Interests of an Office Holder; Approval of Transactions with Office Holders

The
Israeli Companies Law requires that an office holder promptly, and no later than the first
board meeting at which such transaction is considered, disclose any personal interest that
he or she may have and all related material information known to him or her and any
documents in their position, in connection with any existing or proposed transaction by
us. In addition, 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 the office
holders spouse, siblings, parents, grandparents, descendants, spouses
descendants and the spouses of any of the foregoing, or by any corporation in which the
office holder or a relative is a 5% or greater shareholder, director or general manager or
in which he or she has the right to appoint at least one director or the general manager.

Under
the Israeli Companies Law, all arrangements as to compensation of office holders who are
not directors require approval by the board of directors, and exculpation, insurance and
indemnification of, or an undertaking to, indemnify an office holder who is not a director
requires both board of directors and audit committee approval. The compensation of office
holders who are directors must be approved by our audit committee, board of directors and
shareholders.

52

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Some
transactions, actions and arrangements involving an office holder (or a third party in
which an office holder has an interest) must be approved by the board of directors or as
otherwise provided for in a companys articles of association, however, a transaction
that is adverse to the companys interest may not be approved. In some cases, such a
transaction must be approved by the audit committee and by the board of directors itself,
and under certain circumstances shareholder approval may be required. A director who has a
personal interest in a transaction that 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 the transaction, unless the transaction is not
an extraordinary transaction or the majority of the members of the board or the audit
committee have a personal interest, as the case may be. In the event the majority of the
members of the board of directors or the audit committee have a personal interest, then
the approval of the general meeting of shareholders is also required.

Disclosure of Personal
Interests of a Controlling Shareholder; Approval of Transactions with Controlling Shareholders

The
disclosure requirements that apply to an office holder also apply to a transaction in
which a controlling shareholder with respect to his or her personal interest in any
existing or proposed transaction by us. The Israeli Companies Law provides that an
extraordinary transaction with a controlling shareholder or an extraordinary transaction
with another person in whom the controlling shareholder has a personal interest or a
transaction with a controlling shareholder or his relative regarding terms of service and
employment, must be approved by the audit committee, the board of directors and
shareholders. The shareholder approval for such a transaction must include at least
one-third of the shareholders who have no personal interest in the transaction who voted
on the matter (not including abstentions). The transaction can be approved by shareholders
without this one-third approval if the total shareholdings of those shareholders who have
no personal interest and voted against the transaction do not represent more than one
percent of the voting rights in the company.

Under
the Companies Regulations (Relief from Related Party Transactions), 5760-2000, promulgated
under the Israeli Companies Law, as amended, certain extraordinary transactions between a
public company and its controlling shareholder(s) do not require shareholder approval. In
addition, under such regulations, directors compensation and employment arrangements
in a public company do not require the approval of the shareholders if both the audit
committee and the board of directors agree that such arrangements are solely for the
benefit of the company. Also, employment and compensation arrangements for an office
holder that is a controlling shareholder of a public company do not require shareholder
approval if certain criteria are met. The foregoing exemptions from shareholder approval
will not apply if one or more shareholders holding at least 1% of the issued and
outstanding share capital of the company or of the companys voting rights, objects
to the use of these exemptions provided that such objection is submitted to the company in
writing not later than fourteen days from the date of the filing of a report regarding the
adoption of such resolution by the company pursuant to the requirements of the Israeli
Securities Law, 5328-1968. If such objection is duly and timely submitted, then the
transaction or compensation arrangement of the directors will require shareholders
approval as detailed above.

In
addition, a private placement of securities requires the approval of the board of
directors and shareholders of the company if (i) the private placement will cause a person
to become a controlling shareholder or (ii) 20% or more of the companys outstanding
share capital prior to the private placement are offered and the payment for which (in
whole or in part) is not in cash or registered securities or that is not under market
terms, and the private placement will increase the relative holdings of a shareholder that
holds 5% or more of the companys outstanding share capital or will cause any person
to become a holder of more than 5% of the companys outstanding share capital. Other
than as described, under Israeli law private placements require the approval of the board
of directors.

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
become a 25% or greater shareholder of the company. This rule does not apply if there is
already 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, (i) the
acquisition was made in a private placement that received shareholder approval, (ii) was
from a 25% or greater shareholder of the company which resulted in the acquirer becoming a
25% or greater shareholder of the company, if there is not already a 25% or greater
shareholder of the company, or (iii) was from a shareholder holding a 45% interest in the
company which resulted in the acquirer becoming a holder of a 45% interest in the company
if there is not already a 45% or greater shareholder of the company.

53

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If,
as a result of an acquisition of shares, the acquirer will hold more than 90% of a public
companys outstanding shares or a class of shares, the acquisition must be made by
means of a tender offer for all of the outstanding shares or a class of 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 acquirer may not
acquire shares in the tender offer that will cause his shareholding to exceed 90% of the
outstanding shares.

# Exculpation,
Indemnification and Insurance of Directors and Officers

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

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

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

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

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Limitations
on Exculpation, Insurance and Indemnification. The Israeli Companies Law provides that
neither a provision of the articles of association permitting the company to enter into a
contract to insure the liability of an office holder, nor a provision in the articles of
association or a resolution of the board of directors permitting the indemnification of an
office holder, nor a provision in the articles of association exculpating an office holder
from duty to the company shall be valid, where such insurance, indemnification or
exculpation relates to any of the following: (i) a breach by the office holder of his
fiduciary duty unless, with respect to insurance coverage or indemnification, the office
holder acted in good faith and had a reasonable basis to believe that the act would not
prejudice the company; (ii) a breach by the office holder of his duty of care if such
breach was committed intentionally or recklessly, unless the breach was committed only
negligently; (iii) any act or omission done with the intent to unlawfully yield a personal
benefit; or (iv) any fine or forfeiture imposed on the office holder.

Pursuant
to the Israeli Companies Law, exculpation of, procurement of insurance coverage for, and
an undertaking to indemnify or indemnification of, our office holders must be approved by
our audit committee and board of directors and, if the office holder is a director, also
by our shareholders.

Our
Articles of Association allow us to insure, indemnify and exempt our office holders to the
fullest extent permitted by Israeli law. We maintain a directors and officers
liability insurance policy with a per claim and aggregate coverage limit of $10 million,
including legal costs incurred in Israel. Our Audit Committee and Board of
Directors have resolved to increase the aggregate coverage limit of our directors and
officers liability insurance to $ 10 million, which increase is subject to the approval of
our shareholders. 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. To
date, we have provided letters of indemnification to certain of our officers and
directors.

|D. | Employees
|-- | ---------

As
of December 31, 2008, we employed 321 full-time employees, of whom 39 were employed in
general management and administration, 45 were employed in selling and marketing, 22 were
employed in production management, 164 were employed in production, installation and
maintenance, and 51 were employed in engineering and research and development. Of such
full-time employees, 151 were located in Israel, 29 were in the United States, 89 were in
Canada and 52 were in various other countries.

As
of December 31, 2007, we employed 303 full-time employees, of whom 38 were employed in
general management and administration, 42 were employed in marketing, 22 were employed in
production management, 149 were employed in production, installation and maintenance, and
52 were employed in engineering and research and development. Of such full-time employees,
143 were located in Israel, 34 were in the United States, 81 were in Canada and 45 were in
various other countries.

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

Our
relationships with our employees in Israel are governed by Israeli labor legislation and
regulations, extension orders of the Israeli Ministry of Labor and personal employment
agreements. 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. Such laws, agreements and arrangements cover a
wide range of areas, including minimum employment standards, such as working hours,
minimum wages, vacation, procedures for dismissing employees, 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 companies in
their area of operations.

55

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

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

The
following table sets forth certain information regarding the ownership of our ordinary
shares by our directors and executive officers as of June 30, 2009.

|Name                             | Number of Ordinary Shares
Owned(1) | Percentage of Outstanding
Ordinary Shares(2)
|-------------------------------- | ---------------------------------- | --------------------------------------------
|
|
|
|
|Jacob Perry                      |                                    |                                             
|Hagai Katz                       |                                    |                                             
|Zev Morgensten                   |                                    |                                             
|Asaf Even-Ezra (3)               |                                    |                                             
|Yehonatan Ben-Hamozeg            |                                    |                                             
|Jacob Even-Ezra (4)              |                                    |                                             
|Nathan Kirsh (5)                 |                                    |                                             
|Shaul Kobrinsky                  |                                    |                                             
|Zeev Livne                       |                                    |                                             
|Jacob Nuss                       |                                    |                                             
|Barry Stiefel                    |                                    |                                             
|Anat Winner                      |                                    |                                             
|All directors and executive      |                                    |                                             
|officers as a group (12 persons) |                                    |                                             
|                                 |                                    |                                             

---

|*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 10,396,548 ordinary shares issued and
               outstanding as of June 30, 2009.
|--- | ------------------------------------------------------------------------------------------------------------------------

|(3) | Includes
9,000 ordinary shares issuable upon the exercise of currently                exercisable
options, having an exercise price of $8.56 per share that expire in
               December 2010. Asaf Even-Ezra is Jacob Even-Ezras son.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes
76,915 ordinary shares held by a trustee. Jacob Even-Ezra is the father                of
Asaf Even-Ezra.
|--- | ------------------------------------------------------------------------------------------------------------------

|(5) | Based
upon a Schedule 13D/A filed with the Securities and Exchange Commission on
               January 16, 2009 and other information available to the company. Includes:
(i)                346,375 ordinary shares held of record by Mr. Kirsh; (ii) 1,485,852
ordinary                shares held of record by Mira Mag Inc., or Mira Mag, a company
organized in                Liberia; and (iii) 684,041 ordinary shares held of record by
Ki Corporation                Limited, or Ki Corporation, a company organized in Liberia.
The Eurona                Foundation holds 100% of Ki Corporation. Ki Corporation holds
100% of the shares                of Mira Mag. The Eurona Foundation is a Liechtenstein
trust controlled by Mr.                Kirsh, who also serves as its trustee. Mr. Kirsh
may be deemed to have                beneficial ownership of the ordinary shares held of
record by Mira Mag and Ki                Corporation.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

56

---

---

# 2003 Israeli Share
Option Plan

On
October 27, 2003, our board of directors adopted our 2003 Israeli Share Option Plan, or
the 2003 Plan, which was approved by our shareholders in July 2004. 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 vesting schedule of such options and
the exercise price. Under the 2003 Plan, unless determined otherwise by the Board, 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 2003 Plan, any options that are cancelled or not exercised within
the option period will become available for future grants. Our board of directors has
elected to allot options to Israeli employees under Israels capital gain tax
treatment.

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.

In
May 2008, our board of directors approved an amendment to the 2003 Plan, which was
approved by our shareholders in August 2008, that increased the number of ordinary shares
available for issuance under the 2003 Plan by 1,000,000, and extended the termination of
the 2003 Plan from October 2013 to October 2018.

As
of December 31, 2008, options to purchase 724,500 ordinary shares were outstanding under
the 2003 Plan, exercisable at an average exercise price of 7.92 per share. None of the
options awarded under the 2003 Plan were exercised during 2008. As of December 31, 2008,
894,075 ordinary shares remained available for future option grants under the 2003 Plan.

|ITEM 7. |  | Major Shareholders and Related Party Transactions
|------- |  | -------------------------------------------------

|A. | Major
Shareholders
|-- | ------------------

The
following table sets forth certain information as of June 30 , 2009 regarding the
beneficial ownership of our ordinary shares, by each person or entity known to us to own
beneficially 5.0% or more of our ordinary shares.

|Name                                                     | Number of
Ordinary Shares
Beneficially Owned(1) | Percentage of
Outstanding
Ordinary Shares(2)
|-------------------------------------------------------- | ----------------------------------------------- | --------------------------------------------
|
|
|
|
|Nathan Kirsh (3)                                         |                                                 |                                             
|Diker Management LLC (4)                                 |                                                 |                                             
|Clough Capital Partners L.P. (5)                         |                                                 |                                             
|Grace & White, Inc. (6)                                  |                                                 |                                             
|Prescot Group Aggressive Small Cap Master Fund, G.P. (7) |                                                 |                                             

---

|(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
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 10,396,548 ordinary shares issued and
               outstanding as of June 30, 2009.
|--- | ------------------------------------------------------------------------------------------------------------------------

57

---

---

|(3) | Based
upon a Schedule 13D/A filed with the Securities and Exchange Commission on
               January 16, 2009 and other information available to the company. Includes:
(i)                346,375 ordinary shares held of record by Mr. Kirsh; (ii) 1,485,852
ordinary                shares held of record by Mira Mag Inc., or Mira Mag, a company
organized in                Liberia; and (iii) 684,041 ordinary shares held of record by
Ki Corporation                Limited, or Ki Corporation, a company organized in Liberia.
The Eurona                Foundation holds 100% of Ki Corporation. Ki Corporation holds
100% of the shares                of Mira Mag. The Eurona Foundation is a Liechtenstein
trust controlled by Mr.                Kirsh, who also serves as its trustee. Mr. Kirsh
may be deemed to have                beneficial ownership of the ordinary shares held of
record by Mira Mag and Ki                Corporation.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Based
solely upon, and qualified in its entirety with reference to, a Schedule
               13G/A filed with the Securities and Exchange Commission on February 17,
2009.                The Schedule 13G/A indicates that as the sole general partner of
certain Diker                partnerships with respect to stock directly owned by certain
Diker funds, or the                Diker Funds, Diker GP, has the power to vote and
dispose of the shares owned by                the Diker Funds and, accordingly, may be
deemed the beneficial owner of such                shares. Pursuant to investment
advisory agreements, Diker Management, LLC serves                as the investment
manager of the Diker Funds. Accordingly, Diker Management may                be deemed
the beneficial owner of shares held by the Diker Funds. Charles M.                Diker
and Mark N. Diker are the managing members of each of Diker GP, LLC and
               Diker Management LLC, and in that capacity direct their operations.
Therefore,                Charles M. Diker and Mark N. Diker may be deemed the beneficial
owners of shares                beneficially owned by Diker GP, LLC and Diker Management
LLC. Diker GP, LLC,                Diker Management LLC, Charles M. Diker and Mark N.
Diker disclaim all beneficial                ownership, however, as affiliates of a
registered investment adviser, and in any                case disclaim beneficial
ownership except to the extent of their pecuniary                interest in the shares.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Based
solely upon, and qualified in its entirety with reference to, a Schedule
               13G/A filed with the Securities and Exchange Commission on February 10,
2009.                The Schedule 13G/A indicates that the shares include shares
beneficially owned                by investment companies, pooled investment vehicles and
other accounts for which                Clough Capital Partners L.P. serves as investment
adviser. Such shares may be                deemed beneficially owner by (a) Clough
Capital Partners L.P., (b) Clough                Capital Partners LLC, the general
partner of Clough Capital Partners L.P., and                (c) Messrs. Charles Clough,
James Canty and Eric Brock, the managing members of                Clough Capital
Partners LLC. Each such reporting person disclaims beneficial                ownership of
such shares except to the extent of its respective pecuniary                interest
therein.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Based
solely upon, and qualified in its entirety with reference to, a Schedule
               13G/A filed with the Securities and Exchange Commission on February 4,
2009. The                Schedule 13G/A indicates that Grace & White, Inc. is a
registered investment                adviser.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Based
solely upon, and qualified in its entirety with reference to, a Schedule
               13G/A filed with the Securities and Exchange Commission on February 10,
2009.                The Schedule 13G/A indicates that Prescott Group Aggressive Small
Cap, L.P. and                Prescott Group Aggressive Small Cap II, L.P., referred to
together as the Small                Cap Funds, are the general partners of Prescot Group
Aggressive Small Cap Master                Fund, G.P., or Prescott Master Fund. Prescott
Group Capital Management, L.L.C.,                or Prescott Capital, serves as the
general partner of the Small Cap Funds and                may direct the Small Cap Funds,
the general partners of Prescott Master Fund, to                direct the vote and
disposition of the ordinary shares held by the Master Fund.                Mr. Frohlich,
the principal of Prescott Capital, may direct the vote and                disposition of
the ordinary shares held by Prescott Master Fund.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Significant Changes in
the Ownership of Major Shareholders

As
of December 26, 2005, Mr. Nathan Kirsh beneficially owned 1,832,227 or 17.66% of our
ordinary shares, in accordance with a Schedule 13D/A filed with the Securities and
Exchange Commission, or SEC on February 13, 2006. On January 10, 2008, Mr. Nathan Kirsh
filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 1,913,601, or
18.41% of our ordinary shares. On April 24, 2008, Mr. Nathan Kirsh filed a Schedule 13D/A
with the SEC reflecting beneficial ownership of 2,191,162, or 21.08% of our ordinary
shares. On April 25, 2008, Mr. Nathan Kirsh filed a Schedule 13D/A with the SEC reflecting
beneficial ownership of 2,191,162, or 21.08% of our ordinary shares. On January 16, 2009,
Mr. Nathan Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of
2,516,268, or 24.20% of our ordinary shares.

58

---

---

On
February 6, 2007, Clough Capital Partners, L.P. filed an amendment to its Schedule 13G, on
Schedule 13G/A, with the SEC reflecting beneficial ownership of 711,669 or 6.85% of our
ordinary shares. On February 11, 2008, Clough Capital Partners, L.P. filed an amendment to
the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 712,269 or 6.85%
of our ordinary shares. On February 10, 2009, Clough Capital Partners, L.P. filed with the
SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership
of 770,842 or 7.41% of our ordinary shares.

On
February 2, 2007, Diker GP, LLC, Diker Management LLC, or Diker Management, Messrs.
Charles M. Diker and Mark N. Diker filed a Schedule 13G with the SEC reflecting beneficial
ownership of 1,007,601 or 9.70% of our ordinary shares. On February 12, 2008, the
foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on
Schedule 13G/A, reflecting beneficial ownership of 1,014,425, or 9.76%, of our ordinary
shares. On February 17, 2009, the foregoing reporting persons filed with the SEC an
amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of
968,468 or 9.32% of our ordinary shares.

On
February 4, 2008, Grace & White, Inc. filed a Schedule 13G with the SEC reflecting
beneficial ownership of 574,254 or 5.52% of our ordinary shares. On February 10, 2009,
Grace & White, Inc. filed with the SEC an amendment to the Schedule 13G, on Schedule
13G/A, reflecting beneficial ownership of 596,148 or 5.73% of our ordinary shares.

On
February 14, 2008, Prescott Capital, Prescott Group Aggressive Small Cap, L.P., Prescott
Group Aggressive Small Cap II, L.P. and Mr. Phil Frohlich filed a Schedule 13G with the
SEC reflecting beneficial ownership of 539,097 or 5.19% of our ordinary shares. On
February 10, 2009, the foregoing reporting persons filed with the SEC an amendment to the
Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 547,127 or 5.3% of our
ordinary shares.

# Major Shareholders
Voting Rights

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

# Record Holders

Based
on a review of the information provided to us by our transfer agent, as of July 10, 2009,
there were 58 holders of record of our ordinary shares, of which 46 record holders holding
approximately 77.14% of our ordinary shares had registered addresses in the United States.
These numbers are not representative of the number of beneficial holders of our shares nor
is it representative of where such beneficial holders reside since many of these ordinary
shares were held of record by brokers or other nominees, including CEDE & Co., the
nominee for the Depositary Trust Company (the central depositary for the U.S. brokerage
community), which held approximately 76.93% of our outstanding ordinary shares as of such
date.

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

On
January 22, 2008, we entered into a retirement agreement with Mr. Jacob Even-Ezra, who
retired from his position as the chairman of our board of directors as of January 1, 2008,
based on the terms approved by our shareholders in August 2007. Subsequent to the annual
general meeting of our shareholders held in August 2007, our board of directors required
that Mr. Even-Ezras retirement agreement be amended to include a non-compete
undertaking. Pursuant to the retirement agreement, as amended, Mr. Even- Ezra has
undertaken not to compete with our company for a period of three years following his
retirement. In consideration, we agreed to pay Mr. Even-Ezra $360,000. Such amendment was
approved in January 2008 by our audit committee and board of directors without shareholder
approval in accordance with the Companies Regulations (Relief from Related Party
Transactions) 5760-2000, promulgated under the Israeli Companies Law, since such amendment
is solely for the benefit of the our company. In the event that within 14 days from the
date of the disclosure of the resolution of the audit committee and the board of directors
shareholders holding at least 1% of our voting rights will so request, such resolution
will be subject to the approval of the general meeting of our shareholders. In addition,
as gratitude for his long term and outstanding efforts to further our business and
interests, we agreed to provide to Mr. Even-Ezra with certain benefits and services, the
value thereof presently estimated to be $50,000 per year, for the rest of his life. As of
December 31, 2008, the actuarial value of these perquisites is estimated by approximately
$603,000.

59

---

---

On
August 21, 2008, we entered into an agreement with Mr. Jacob Perry, in connection with his
services as the chairman of our board of directors. Pursuant to the terms of the
agreement, Mr. Perry agreed to serve as the chairman of our board of directors on a part
time basis and has undertaken to devote 50%-60% of his business time and attention to the
development of our business. Mr. Perrys service as the chairman of our board of
directors is for an unlimited period, however each party may terminate the agreement
without cause by giving 90 days notice to the other party. Mr. Perry is entitled to
receive as compensation for his services as chairman of our board of directors a monthly
fee of NIS 50,000 (approximately $13,000) effective as of the date of his appointment as
chairman of our board of directors on January 1, 2008. Such compensation is linked to the
Israeli consumer price index and will be adjusted every six months. In addition, in the
event that our annual income before taxes (after deduction of any and all bonuses paid to
all other employees including our chief executive officer, and excluding any non-recurring
capital gain or loss), will be higher than $3,000,000, or the Base Amount we will pay Mr.
Perry an annual bonus that will be equal to 5% of our companys annual income before
taxes, but in any event not more than $500,000 per year. On January 1 of each year, the
Base Amount is increased by 10% per year. Mr. Perry is also entitled to receive all
customary social benefits such as managers insurance and education fund, such amount will
be paid to him or to third parties for his benefit. In November 2008, our agreement with
Mr. Perry was amended, pursuant to which until September 1, 2008, Mr. Perry was engaged by
us as an as independent contractor through a company controlled by him and after September
1, 2008, is an employee of our company. Such amendment was approved in January 2008 by our
audit committee and board of directors without shareholder approval in accordance with the
Companies Regulations (Relief from Related Party Transactions) 5760-2000, promulgated
under the Israeli Companies Law, since such amendment is solely for the benefit of the our
company. In the event that within 14 days from the date of the disclosure of the
resolution of the audit committee and the board of directors shareholders holding at least
1% of our voting rights will so request, such resolution will be subject to the approval
of the general meeting of our shareholders.

Mr.
          Perry is also the chairman of the board of directors of Mizrahi Tefahot Bank
          B.M. We have a credit line with Mizrahi Tefahot Bank B.M., totaling
          approximately $5.0 million since July 2006. Our board of directors determined
          that this a transaction in the ordinary cause of business, that was made on an
          arms length basis and is in the best interest of our company.

Our
former U.S. subsidiary, Smart Interactive Systems Inc., provided video monitoring services
to companies controlled by Mr. Nathan Kirsh, our principal shareholder and a director. The
terms of the contracts under which we made sales to these companies were negotiated on an
arms length basis and the terms of such contracts were 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 2006 and 2007, were $765,000 and $781,000,
respectively. In December 2007, we disposed of our U.S. based video monitoring business.

In
November 2008, our audit committee and board of directors approved, subject to the
approval of our shareholders, that Mr. Zeev Livne, a director, is entitled to a commission
equal to 1.5% of the net revenues actually received by us from certain transactions in a
number of Eastern European countries.

We
have entered into retirement agreements with our certain of our officers under which we
have paid post employment and retirement liabilities in the aggregate amount of
approximately $2.6 million.  Of such amount, approximately $1.7 million was paid to
Mr. Izhar Dekel, our former President and chief executive officer, who had been employed
by our company and served in various positions from 1984 until February 2009. These
payments include consideration for a non-compete undertaking as well as severance payments
and other retirement related payments in accordance with Mr. Dekels retirement
agreement and Israeli law.

60

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

Not
applicable.

|ITEM 8. |  | Financial Information
|------- |  | ---------------------

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

# Consolidated Financial
Statements

See
the consolidated financial statements included under Item 18, Financial
Statements.

# Export Sales

In
2006, 2007 and 2008, the total amount of our revenues from our facilities located outside
of Israel to customers outside of Israel was approximately $37.0 million, $49.1 million
and $48.3 million, respectively, or 55.2%, 67.9% and 68.7% of our total revenues,
respectively. In 2006, 2007 and 2008, the total amount of our export revenues from our
Israeli facilities to countries outside of Israel was approximately $3.6 million, $7.6
million and $9.9 million, respectively, or 5.4%, 10.5% and 14.1% of our total revenues,
respectively.

# Legal Proceedings

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

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

On
June 6, 2007, the Court of Arbitrationawarded its decision in the arbitration and
stated that the agreement concluded between us and the customer is void due to legal
mistakes made by the customer in the tender process. As a result of this award and as
agreed in the settlement agreement, the performance bank guarantee was cancelled in
February 2008. Based on the above we decided to institute a new legal action against the
customer and seek compensation for the damages we incurred. We initiated the following
motions: (1) on December 10, 2007 a motion for reconciliation was submitted to a Public
Court; and (2) on December 11, 2007 a claim for compensation was submitted to the Court of
Arbitration. In both actions the claim was in the amount of $21,533,998. On February 2008,
the customer denied our request for reconciliation and as a result this process has been
concluded. The arbitration proceeding is still pending.

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.

61

---

---

# Dividend Distribution
Policy

We
currently intend to retain future earnings for use in our business and do not anticipate
paying cash dividends on our ordinary shares in the foreseeable future. Future dividend
distributions are subject to the discretion of our board of directors and will depend on a
number of factors, including our operating results, future capital resources available for
distribution, capital requirements, financial condition, the tax implications of dividend
distributions on our income, future prospects and any other factors our board of directors
may deem relevant.

The
distribution of dividends also may be limited by Israeli law, which permits the
distribution of dividends only out of profits (as defined by the Israeli Companies Law) or
otherwise upon the permission of the court. Profits are defined in the Israeli
Companies Law as the balance of surpluses, or the surpluses accumulated over the past two
years, whichever is the greater, in accordance with the latest adjusted financial
statements, audited or reviewed, prepared by the company, provided that the date in
respect of which the statements were prepared is no earlier than six months prior to the
date of distribution. Surplus means sums included in a companys
shareholders equity originating from the net profit of the company, as determined
according to generally accepted accounting principles, and sums other than share capital
or premiums that are included in shareholders equity under generally accepted
accounting principles and the Minister of Justice prescribed that they are to be
considered surplus.

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

Since
the date of the annual consolidated financial statements included in this annual report,
no significant changes have occurred.

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

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

Annual Stock Information

The
following table sets forth, for each of the years indicated, the high and low market
prices of our ordinary shares on the NASDAQ Global Market and the Tel Aviv Stock Exchange:

|     | NASDAQ Global Market | Tel Aviv Stock Exchange
|---- | -------------------- | -----------------------
|
|
|
|
|2004 |                      |                        
|2005 |                      |                        
|2006 |                      |                        
|2007 |                      |                        
|2008 |                      |                        
|     |                      |                        

Quarterly Stock
Information

The
following table sets forth, for each of the full financial quarters in the years indicated
and any subsequent period, the high and market prices of our ordinary shares on the NASDAQ
Global Market and the Tel Aviv Stock Exchange:

|               | NASDAQ Global Market | Tel Aviv Stock Exchange
|-------------- | -------------------- | -----------------------
|
|
|
|
|2007           |                      |                        
|First Quarter  |                      |                        
|Second Quarter |                      |                        
|Third Quarter  |                      |                        
|Fourth Quarter |                      |                        
|               |                      |                        
|2008           |                      |                        
|First Quarter  |                      |                        
|Second Quarter |                      |                        
|Third Quarter  |                      |                        
|Fourth Quarter |                      |                        
|               |                      |                        
|2009           |                      |                        
|First Quarter  |                      |                        

62

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Monthly Stock Information

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

|              | NASDAQ Global Market | Tel Aviv Stock Exchange
|------------- | -------------------- | -----------------------
|
|
|
|
|December 2008 |                      |                        
|January 2009  |                      |                        
|February 2009 |                      |                        
|March 2009    |                      |                        
|April 2009    |                      |                        
|May 2009      |                      |                        

|B. | Plan
of Distribution.
|-- | ---------------------

Not
applicable.

|C. | Markets.
|-- | --------

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

|D. | Selling
Shareholders.
|-- | ---------------------

Not
applicable.

|E. | Dilution.
|-- | ---------

Not
applicable.

|F. | Expenses
of the Issue.
|-- | ----------------------

Not
applicable.

|ITEM 10. |  | Additional Information
|-------- |  | ----------------------

|A. | Share
Capital.
|-- | --------------

Not
applicable.

63

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|B. | Memorandum
and Articles of Association.
|-- | ---------------------------------------

# Purposes and Objects of
the Company

We
are a public company registered with the Israeli Companies Registrar 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 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 external 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, even if the articles of association do not stipulate so. Our board of directors
has the power to assume the responsibilities of our chief executive officer if he is
unable to act or exercise his powers or if he fails to fulfill the instructions of the
board of directors with respect to a specific matter.

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

The
authority of our directors to enter into borrowing arrangements on our behalf is not
limited, except in the same manner as any other transaction by us.

For
a discussion of Israeli law concerning a directors fiduciary duties and the approval
of transactions with office holders, see Item 6.C. Directors, Senior Management and
Employees-Board Practices  Approval of Related Party Transactions under Israeli
Law.

# Rights Attached to Shares

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

The
rights attached to the ordinary shares are as follows:

Dividends
Rights.

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

64

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The
board of directors may declare interim dividends and propose the final dividend with
respect to any fiscal year only out of the retained earnings, in accordance with the
provisions of the Israeli Companies Law. 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. See Item 8A. Financial Information  Consolidated Statements
and Other Financial Information  Dividend Distributions Policy.

Voting
Rights

Holders
of ordinary shares are entitled to one vote for each share held of record on all matters
submitted to a vote of shareholders. Such voting rights may be affected by the grant of
any special voting rights to the holders of a class of shares with preferential rights
that may be authorized in the future.

Generally,
resolutions are adopted at the general meeting of shareholders by an ordinary resolution,
unless the Israeli Companies Law or our 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 on
the matter. 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 on the matter.
The primary resolutions required to be adopted by an extraordinary resolution of the
general meeting of shareholders are resolutions to:

| |  | amend
the memorandum of association or articles of association;
| | - | ---------------------------------------------------------------

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

| |  | approve
mergers, consolidations or winding up of our company.
| | - | -------------------------------------------------------------

Our
articles of association do not contain any provisions regarding a classified board of
directors or cumulative voting for the election of directors. Pursuant to our articles of
association, our directors (except the external directors) are elected at our annual
general meeting of shareholders by a vote of the holders of a majority of the voting power
represented and voting at such meeting and hold office until the next annual general
meeting of shareholders and until their successors have been elected. All the members of
our board of directors (except the external directors) may be reelected upon completion of
their term of office. For information regarding the election of external directors, see
Item 6C. Directors, Senior Management and Employees  Directors and Senior
Management  Board Practices  Election of Directors.

Rights
to Share in the Company's Profits

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

Liquidation
Rights

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

Redemption

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

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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.

Substantial
limitations on shareholders

See
Item 6.C. Directors, Senior Management and Employees-Board PracticesApproval
of Related PartyTransactions.

# Modifications of Share
Rights

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. 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.

# General Meetings of
Shareholders

Under
the Israeli Companies Law a company must convene an annual meeting of shareholders at
least once every calendar year and within 15 months of the last annual meeting. Depending
on the matter to be voted upon, notice of at least 21 days or 35 days prior to the date of
the meeting is required. Our board of directors may, in its discretion, convene additional
meetings as special general meetings. In addition, the board must convene a
special general meeting upon the demand of two of the directors, 25% of the nominated
directors, one or more shareholders having at least 5% of the outstanding share capital
and at least 1% of the voting power in the company, or one or more shareholders having at
least 5% of the voting power in the company. See this Item 10B. Additional
Information  Memorandum and Articles of Association- Rights Attached to
Shares-Voting Rights.

A
shareholder present, in person or by proxy, at the commencement of a general meeting of
shareholders may not seek the cancellation of any proceedings or resolutions adopted at
such general meeting of shareholders on account of any defect in the notice of such
meeting relating to the time or the place thereof. Shareholders who are registered in our
register of shareholders at the record date may vote at the general meeting of
shareholders. The record date is set in the resolution to convene the general meeting of
shareholders, provided, however, that such record date must be between 14 to 21 days or,
in the event of a vote by ballots, between 28 to 40 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.

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# Provisions Restricting a
Change in Control of Our Company

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

# Disclosure of
Shareholders Ownership

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

|C. | Material
Contracts.
|-- | -------------------

None.

|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.

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# ISRAELI TAX
CONSIDERATIONS

The
following is a summary of the material Israeli tax laws applicable to us, and some Israeli
Government programs benefiting us. This section also contains a discussion of material
Israeli tax consequences concerning the ownership of and disposition of our ordinary
shares. This summary does not discuss all the acts 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. Examples of this
kind of investor include residents of Israel or traders in securities who are subject to
special tax regimes not covered in this discussion. Since some parts of this discussion
are based on new tax legislation that has not yet been subject to judicial or
administrative interpretation, we cannot assure you that the appropriate tax authorities
or the courts will accept the views expressed in this discussion.

The
discussion below should not be construed as legal or professional tax advice and does not
cover all possible tax considerations. Potential investors are urged to consult their own
tax advisors as to the Israeli or other tax consequences of the purchase, ownership and
disposition of our ordinary shares, including in particular, the effect of any foreign,
state or local taxes.

# General Corporate Tax
Structure

Israeli
companies are subject to income tax on their worldwide income regardless of the
territorial source of such income. Generally, Israeli companies are subject to
corporate tax on their taxable income. On July 25, 2005, the Knesset (Israeli
Parliament) approved the Law of the Amendment of the Income Tax Ordinance (No. 147), 2005,
or the Israel Tax Ordinance, 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%.
Capital gains derived after January 1, 2003 (other than gains derived from the sale of
listed securities that are taxed at the prevailing corporate tax rates) are generally
subject to tax at a rate of 25%. 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.

Following
an amendment to the Israeli Tax Ordinance, which came into effect on January 1, 2009, an
Israeli corporation may elect a 5% rate of corporate tax (instead of 25%) for income from
dividend distributions received from a foreign subsidiary which is used in Israel in 2009,
or within one year after actual receipt of the dividend, whichever is later. The 5% tax
rate is subject to various conditions, which include conditions with regard to the
identity of the corporation that distributes the dividends, the source of the dividend,
the nature of the use of the dividend income, and the period during which the dividend
income will be used in Israel.

# Israeli Transfer Pricing
Regulations

On
November 29, 2006, Income Tax Regulations (Determination of Market Terms), 2006,
promulgated under Section 85A of the Israeli Tax Ordinance, came into effect, or the TP
Regs. Section 85A of the Tax Ordinance and the TP Regs generally require that all
cross-border transactions carried out between related parties be conducted on an
arms length principle basis and will be taxed accordingly. The TP Regs are not
expected to have a material affect on us.

# Tax Benefits for
Research and Development

Israeli
tax law allows, under specified conditions, a tax deduction for expenditures, including
capital expenditures, in the year incurred relating to scientific research and development
projects, if the expenditures are approved by the relevant Israeli Government ministry,
determined by the field of research, and the research and development is for the promotion
of the company and is carried out by or on behalf of the company seeking such deduction.
However, the amount of such deductible expenses shall be reduced by the sum of any funds
received through government grants for the finance of such scientific research and
development projects. Expenditures not so approved are deductible over a three-year period.

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# Encouragement of Capital
Investments Law, 5719-1959

# The Investments Law
Prior to the 2005 Amendment

The
Law for the Encouragement of Capital Investments, 1959, or the Investments Law, as in
effect prior to April 1, 2005 provided that a proposed capital investment in eligible
facilities may, upon application to the Investment Center of the Ministry of Industry and
Commerce of the State of Israel, be designated as an approved enterprise. The Investment
Center based its decision as to whether or not to approve an application, among other
things, on the criteria set forth in the Investments Law and regulations, the then
prevailing policy of the Investment Center, and the specific objectives and financial
criteria of the applicant. 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, such as the equipment to be
purchased and utilized pursuant to the program.

The
Investments Law provides that an approved enterprise is eligible for tax benefits on
taxable income derived from its approved enterprise programs. The tax benefits under the
Investments Law also apply to income generated by a company from the grant of a usage
right with respect to know-how developed by the approved enterprise, income generated from
royalties, and income derived from a service which is auxiliary to such usage right or
royalties, provided that such income is generated within the approved enterprises
ordinary course of business. If a company has more than one approval enterprise or only a
portion of its capital investments are approved, its effective tax rate is the result of a
weighted average of the applicable rates. The tax benefits under the Investments Law are
not, generally, available with respect to income derived from products manufactured
outside of Israel. In addition, the tax benefits available to an approved enterprise are
contingent upon the fulfillment of conditions stipulated in the Investments Law and
regulations and the criteria set forth in the specific certificate of approval, as
described above. In the event that a company does not meet these conditions, it would be
required to refund the amount of tax benefits, plus a consumer price index linkage
adjustment and interest.

The
Investments Law also provides that an approved enterprise is entitled to accelerated
depreciation on its property and equipment that are included in an approved enterprise
program.

Taxable
income of a company derived from an approved enterprise is subject to corporate tax at the
maximum rate of 25%, rather than the regular corporate tax rate, for the benefit period.
This period is ordinarily seven years commencing with the year in which the approved
enterprise first generates taxable income (after the commencement of production), and is
limited to 12 years from commencement of production or 14 years from the date of approval,
whichever is earlier, referred to as the Years Limitation.

A
company may elect to receive an alternative package of benefits. Under the alternative
package of benefits, a companys undistributed income derived from the approved
enterprise will be exempt from corporate tax for a period of between two and ten years
from the first year the company derives taxable income under the program, depending on the
geographic location of the approved enterprise within Israel, and such company will be
eligible for a reduced tax rate for the remainder of the benefits period. The Years
Limitation does not apply to the exemption period. A company that has elected the
alternative package of benefits, such as us, that subsequently pays a dividend out of
income derived from the approved enterprise during the tax exemption period will be
subject to corporate tax in respect of the gross amount distributed, including any taxes
thereon, at the rate which would have been applicable had it not elected the alternative
package of benefits, generally 10%-25%, depending on the percentage of the companys
ordinary shares held by foreign shareholders. The dividend recipient is subject to
withholding tax at the rate of 15% applicable to dividends from approved enterprises, if
the dividend is distributed during the tax exemption period or within twelve years
thereafter. The company must withhold this tax at source.

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 which more than 25% of its 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. As specified above, depending on the geographic location of the approved
enterprise within Israel, income derived from the approved enterprise program may be
exempt from tax on its undistributed income for a period of between two to ten years, and
will be subject to a reduced tax rate for the remainder of the benefits period. The tax
rate for the remainder of the benefits period will be 25%, unless the level of foreign
investment exceeds 49%, in which case the tax rate will be 20% if the foreign investment
is more than 49% and less than 74%; 15% if more than 74% and less than 90%; and 10% if 90%
or more.

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Subject
to applicable provisions concerning income under the alternative package of benefits,
dividends paid by a company are considered to be attributable to income received from the
entire company and the companys effective tax rate is the result of a weighted
average of the various applicable tax rates, excluding any tax-exempt income. Under the
Investments Law, a company that has elected the alternative package of benefits is not
obliged to distribute retained profits, and may generally decide from which years
profits to declare dividends. We currently intend to reinvest any income derived from our
approved enterprise program and not to distribute such income as a dividend.

The
Israeli government may reduce or eliminate tax benefits available to approved enterprise
programs in the future. We cannot assure you that our approved program and the benefits
thereunder shall continue in the future at its current level or at any level.

Currently,
we have two valid expansion programs that were granted approved enterprise status under
the Investments Law prior to its amendment.

# 2005 Amendment to the
Investments Law

An
amendment to the Investments Law, which was published on April 1, 2005, or the Amendment,
has changed certain provisions of the Investments Law. As a result of the Amendment, a
company is no longer obliged to acquire approved enterprise status in order to receive the
tax benefits previously available under the alternative benefits provisions, and therefore
generally 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 Investments 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, referred to as a Benefited Enterprise. In order to receive the
tax benefits, the Amendment states that the company must make an investment in the
Benefited Enterprise exceeding a certain percentage or a minimum amount specified in the
Investments Law. Such investment may be made over a period of no more than three years
ending at the end of the year in which the company requested to have the tax benefits
apply to the Benefited Enterprise, referred to as the Year of Election. Where the company
requests to have the tax benefits apply to an expansion of existing facilities, then only
the expansion will be considered a Benefited 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 Benefited Enterprise is
required to exceed a certain percentage or a minimum amount of the companys
production assets before the expansion.

The
duration of tax benefits is subject to a limitation of the earlier of seven to ten years
from the commencement year, or 12 years from the first day of the Year of Election. The
tax benefits granted to a Benefited Enterprise are determined, as applicable to its
geographic location within Israel, according to one of the following new tax routes, which
may be applicable to us:

| |  | 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 Benefited Enterprise 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 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 Benefited Enterprise during the tax exemption
period, such income will be subject to corporate tax at the applicable rate (10%-25%)
with respect to the gross amount of dividend distributed. The company is required to
withhold tax at the source at a rate of 15% from any dividends distributed from income
derived from the Benefited Enterprise; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | A
special tax route, which enables companies owning facilities in certain geographical
locations in Israel to pay corporate tax at the rate of 11.5% on income of the Benefited
Enterprise. 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 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 are
retroactive from 2003.

The
Amendment applies to approved enterprise programs in which the year of election under the
Investments Law is 2004 or later, unless such programs received Approved
Enterprise approval from the Investment Center on or prior to December 31, 2004, in
which case the Amendment provides that terms and benefits included in any certificate of
approval already granted will remain subject to the provisions of the Investments Law as
they were on the date of such approval.

Should
we elect to utilize tax benefits under the Amendment to the Investments Law, any such tax
exempt profits might be subject to future taxation on the corporate level upon
distribution to shareholders by a way of dividend or liquidation. Accordingly, we may be
required to recognize deferred tax liability with respect to such tax exempt profits.

A
substantial portion of our taxable operating income is derived from our approved
enterprise program and we expect that a substantial portion of any taxable operating
income that we may realize in the future will be also derived from such program. There is
no assurance that our facilities will continue to enjoy such status in the future.

On
March 3, 2007, we received a pre-ruling from the Israeli Tax Authority confirming that our
most recent development program will be deemed a Benefiting Enterprise under the amended
Investments Law. Our income from this program is tax-exempt for a period of two years, and
is subject to a reduced tax rate of 10%-25 for a period of five to eight years (depending
upon the percentage of foreign ownership of the Company). We have not enjoyed any tax
benefits under this program to date.

# Encouragement of
Industry (Taxes) Law, 5729-1969

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

| |  | Amortization,
under certain conditions, of purchases of know-how and patents and of rights to use a
patent and know-how which are used for the development or advancement of the company,
over an eight-year period for tax purposes;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Right
to elect, under specified conditions, to file a consolidated tax return with additional
related Israeli industrial companies; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | Accelerated
depreciation rates on equipment and buildings; and
| | - | --------------------------------------------------------------

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| |  | Deductions
over a three-year period of expenses in connection with the issuance and listing of
shares on a recognized stock market.
| | - | -----------------------------------------------------------------------------------------------------------------------------------

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

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

# Encouragement of
Industrial Research and Development Law, 5744-1984

Under
the Encouragement of Industrial Research and Development Law, 5744-1984, or the Research
Law, research and development programs that meet specified criteria and are approved by a
governmental committee of the Office of the Chief Scientist of the Israeli Ministry of
Industry, Trade and Labor, or the OCS, are eligible for grants between 20%-50% of certain
of the projects expenditures, as determined by the research committee of the OCS. 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 to 100% 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 regulations promulgated under
the Research Law, upon the approval of the OCS, some of the manufacturing volume may be
performed outside Israel, provided that the grant recipient pays royalties at an increased
rate. The Research Law also allows for the approval of grants in cases in which the
applicant declares that part or all of the manufacturing will be performed outside of
Israel or by foreign residents and the research committee of the OCS 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 of the OCS. 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.

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.

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

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

# Taxation under
Inflationary Conditions

The
Income Tax (Inflationary Adjustments) Law, 5745- 1985, generally referred to as the
Inflationary Adjustments Law, represents an attempt to overcome the problems presented to
a traditional tax system by an economy undergoing rapid inflation. The Inflationary
Adjustments Law is highly complex. Its features which are material to us can be described
as follows:

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

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

| |  | Subject
to specified limitations, depreciation deductions on fixed assets and losses carried
forward are adjusted for inflation based on the increase in the Israeli consumer price
index.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Inflationary Adjustments Law was abolished, effective as of January 1 2008, and subject to
transitional provisions and special provisions to prevent a distortion in the tax
calculations. In February 2008, the Knesset passed an amendment to the Income Tax
(Inflationary Adjustments) Law, 1985, which limits the scope of the law with effect from
2008 and thereafter. From 2008, the results for tax purposes will be measured in nominal
values, excluding certain adjustments for changes in the Israeli consumer price index
carried out in the period up to December 31, 2007. The amended law includes, among other
things, the elimination of the inflationary additions and deductions and the additional
deduction for depreciation with effect from 2008.

# Capital Gains Tax on
Sales of Our Ordinary Shares by Foreign Holders

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

| |  | The
capital gain is not attributable to a permanent establishment in Israel.
| | - | ----------------------------------------------------------------------------

73

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| |  | The
shares were purchased after the first initial public offering on the recognized stock
exchange outside of Israel.
| | - | ---------------------------------------------------------------------------------------------------------------------

| |  | The
provisions of the Income Tax Law (Inflationary Adjustments), 1985 do not apply to such
gain
| | - | -----------------------------------------------------------------------------------------------

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

Under
the U.S.-Israel Tax Treaty, the sale, exchange or disposition of our ordinary shares by a
shareholder who is a U.S. resident (for purposes of the U.S.-Israel Tax Treaty) holding
the ordinary shares as a capital asset is exempt from Israeli capital gains tax unless
either (i) the shareholder holds, directly or indirectly, shares representing 10% or more
of our voting capital during any part of the 12-month period preceding such sale, exchange
or disposition or (ii) the capital gains arising from such sale are attributable to a
permanent establishment of the shareholder located in Israel. However, under the
U.S.-Israel TaxTreaty, such U.S. resident (for purposes of the U.S.-Israel Tax
Treaty) 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.

# Taxation of Foreign
Holders of Shares

Foreign
residents of Israel are subject to income tax on income accrued or derived from sources in
Israel. Such sources of income include passive income such as dividends, royalties and
interest, as well as non-passive income from services rendered in Israel. On distributions
of dividends after January 1, 2006 other than bonus shares or stock dividends, income tax
at the rate of 20% will be withheld on dividends distributed to Israeli individual
shareholders or to foreign residents, unless a different rate is provided in a treaty
between Israel and the shareholders country of residence. With respect to a person
who is a substantial shareholder at the time receiving the dividend or on any
date in the twelve months preceding it, the applicable tax rate is 25%. A
substantial shareholder is generally a person who alone or together with such
persons relative or another person who collaborates with such person on a permanent
basis, holds, directly or indirectly, at least 10% of any of the means of
control of the corporation. Means of control generally include the right
to vote, receive profits, nominate a director or an officer, receive assets upon
liquidation, or order someone who holds any of the aforesaid rights how to act, and all
regardless of the source of such right. Under the U.S.-Israel Tax Treaty, the maximum rate
of tax withheld in Israel on dividends paid to a holder of our ordinary shares who is a
U.S. resident (for purposes of the U.S.-Israel Tax Treaty) is 25%. However, generally, the
maximum rate of withholding tax on dividends, not generated by our approved enterprise,
that are paid to a U.S. corporation holding 10% or more of our outstanding voting capital
throughout the tax year in which the dividend is distributed as well as the previous tax
year, is 12.5%. Furthermore, dividends paid from income derived from our approved
enterprise are subject, under certain conditions, to withholding at the rate of 15%. We
cannot assure you that we will designate the profits that are being distributed in a way
that will reduce shareholders tax liability.

A
non-resident of Israel who receives dividends from which tax was withheld is generally
exempt from the duty to file returns in Israel in respect of such income, provided such
income was not derived from a business conducted in Israel by the taxpayer, and the
taxpayer has no other taxable sources of income in Israel.

# Controlled Foreign
Corporation

In
general, and subject to the provisions of all relevant legislation, an Israeli resident
who holds, directly of indirectly, 10% or more of the rights in a foreign corporation
whose shares are not publicly traded, in which more than 50% of the rights are held
directly or indirectly by Israeli residents, and a majority of whose income in a tax year
is considered passive income (generally referred to as a Controlled Foreign Corporation),
is liable for tax on the portion of his or her income attributed to holdings in such
corporation, as if such income was distributed to him or her as a dividend.

74

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# UNITED STATES FEDERAL
INCOME TAX CONSEQUENCES

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

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

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

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

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

Taxation of Dividends

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

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

75

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Subject
to complex limitations, any Israeli withholding tax imposed on such dividends will be a
foreign income tax eligible for credit against a U.S. Holders U.S. federal income
tax liability (or, alternatively, for deduction against income in determining such tax
liability). The limitations set out in the Code include computational rules under which
foreign tax credits allowable with respect to specific classes of income cannot exceed the
U.S. federal income taxes otherwise payable with respect to each such class of income.
Dividends generally will be treated as foreign source passive category income or, in the
case of certain U.S. Holders, general category income for United States foreign tax credit
purposes. Further, there are special rules for computing the foreign tax credit limitation
of a taxpayer who receives dividends subject to a reduced rate of tax, see discussion
below. A U.S. Holder will be denied a foreign tax credit with respect to Israeli income
tax withheld from dividends received on the ordinary shares to the extent such U.S. Holder
has not held the ordinary shares for at least 16 days of the 31-day period beginning on
the date which is 15 days before the ex-dividend date or to the extent such U.S. Holder is
under an obligation to make related payments with respect to substantially similar or
related property. Any days during which a U.S. Holder has substantially diminished its
risk of loss on the ordinary shares are not counted toward meeting the 16-day holding
period required by the statute. The rules relating to the determination of the foreign tax
credit are complex, and you should consult with your personal tax advisors to determine
whether and to what extent you would be entitled to this credit.

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

Disposition of Ordinary
Shares

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

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.

76

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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, or 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 in this or 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, or a QEF
election, or to mark to market your ordinary shares, as described below:

| |  | you
would be required to allocate income recognized upon receiving certain dividends or gain
recognized upon the disposition of ordinary shares ratably over the holding period for
such ordinary shares,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
amount allocated to each year during which we are considered a PFIC other than the year
of the dividend payment or disposition would be subject to tax at the highest individual
or corporate tax rate, as the case may be, in effect for that year and an interest charge
would be imposed with respect to the resulting tax liability allocated to each such year,
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
amount allocated to the current taxable year and any taxable year before we became a PFIC
would be taxable as ordinary income in the current year, and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | you
would be required to file an annual return on IRS Form 8621 regarding distributions
received with respect to ordinary shares and any gain realized on your ordinary shares.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

77

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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.

|F. | Dividends
and Paying Agents.
|-- | ----------------------------

Not
applicable.

|G. | Statements
by Experts.
|-- | ----------------------

Not
applicable.

|H. | Documents
on Display.
|-- | ---------------------

We
are subject to certain of the reporting requirements of the Securities and Exchange Act of
1934, as amended, or the Exchange Act, as applicable to foreign private
issuers as defined in Rule 3b-4 under the Exchange Act. As a foreign private issuer,
we are exempt from certain provisions of the Exchange Act. Accordingly, our proxy
solicitations are not subject to the disclosure and procedural requirements of Regulation
14A under the Exchange Act, and transactions in our equity securities by our officers and
directors are exempt from reporting and the 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 as frequently or
as promptly as U.S. companies whose securities are registered under the Exchange Act.
However, we file with the Securities and Exchange Commission an annual report on Form 20-F
containing financial statements audited by an independent accounting firm. We also submit
to the Securities and Exchange Commission reports on Form 6-K containing (among other
things) press releases and unaudited financial information. We post our annual report on
Form 20-F on our website (www.magal-ssl.com) promptly following the filing of our
annual report with the Securities and Exchange Commission. The information on our website
is not incorporated by reference into this annual report.

This
annual report and the exhibits thereto and any other document we file pursuant to the
Exchange Act may be inspected without charge and copied at prescribed rates at the
Securities and Exchange Commission public reference room at 100 F Street, N.E., Room 1580,
Washington, D.C. 20549. You may obtain information on the operation of the Securities and
Exchange Commissions public reference room in Washington, D.C. by calling the
Securities and Exchange Commission at 1-800-SEC-0330. The Exchange Act file number for our
Securities and Exchange Commission filings is 000-21388.

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The
Securities and Exchange Commission maintains a website at www.sec.gov that contains
reports, proxy and information statements, and other information regarding registrants
that make electronic filings with the Securities and Exchange Commission using its EDGAR
(Electronic Data Gathering, Analysis, and Retrieval) system.

The
documents concerning our company that are referred to in this annual report may also be
inspected at our executive offices in Israel.

In
addition, since we are also listed on the Tel Aviv Stock Exchange, we submit copies of all
our filings with the SEC to the Israeli Securities Authority and Tel Aviv Stock Exchange.
Such copies can be retrieved electronically through the Tel Aviv Stock Exchanges
internet messaging system (www.maya.tase.co.il) and, for filings after November 2003, also
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. Our financial expenses are sensitive to the LIBOR and prime interest
rates, since our short-term loans bear prime-based interest rates and of our $3.2 million
long-term loans, $1.4 million bear a fixed interest rate and $1.8 million bear LIBOR
interest rate.

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

|Interest Rate SensitivityPrincipal Amount by
Expected Maturity Date and Weighted Average Interest Rate
|------------------------------------------------------------------------------------------------------
|
|
|
|
|Short-term loans                                                                                      
|Weighted average interest rate                                                                        
|Long-term loans                                                                                       
|Weighted average interest rate                                                                        

# Foreign Currency
Exchange Risk

We
sell most of our products in North America, Europe and Israel. Our revenues are primarily
denominated in U.S. dollars, Euros and NIS, while a portion of our expenses, primarily
labor expenses, is incurred in NIS and Canadian Dollars. Additionally, certain assets,
especially trade receivables, as well as part of our liabilities are denominated in NIS.
As a result, fluctuations in rates of exchange between the U.S. dollar and non-U.S. dollar
currencies may affect our operating results and financial condition. The dollar cost of
our operations in Israel may be adversely affected by the appreciation of the NIS against
the U.S. dollar. In addition, the value of our non-U.S. dollar revenues could be adversely
affected by the depreciation of the U.S. dollar against such currencies. In 2006, 2007 and
2008, the NIS appreciated by approximately 8.2%, 9.0% and 1.1%, respectively, against the
U.S. dollar, which had a significant adverse affect on our results of operations. In 2008,
the Euro depreciated against the U.S. dollar by 5.3%, while in 2007 and 2006, the Euro
appreciated against the U.S. dollar by 11.7% and 11.3%, respectively.

79

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In
addition, the U.S. dollar cost of our operations in Canada is influenced by the exchange
rate between the U.S. dollar and the Canadian dollar. In 2008, the Canadian dollar
depreciated against the U.S. dollar by approximately 19.7%, while in 2007 and 2006, the
Canadian dollar appreciated against the U.S. dollar by 18.4% and 0.4%, respectively.

During
the years ended December 31, 2007 and 2008, foreign currency fluctuations had an adverse
impact on our results of operations and we recorded foreign exchange losses, net of
$792,000 and $246,000, respectively. During the year ended December 31, 2006, we recorded
foreign currency exchange gains, net of $276,000. We cannot assure you that in the future
our results of operations may not be materially adversely affected by currency
fluctuations.

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

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

We
recorded $915,000, $666,000 and $291,000 of financial expenses related to forward
contracts transactions in 2006, 2007 and 2008, respectively.

|ITEM 12. |  | Description of Securities Other Than Equity Securities
|-------- |  | ------------------------------------------------------

Not
applicable.

# PART II

|ITEM 13. |  | Defaults, Dividend Arrearages and Delinquencies
|-------- |  | -----------------------------------------------

Not
applicable.

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

Not
applicable.

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

# Disclosure Controls and
Procedures

We
maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in its Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms, and that such information is accumulated and
communicated to our chief executive officer and chief financial officer to allow timely
decisions regarding required disclosure. Our management, including our chief executive
officer and chief financial officer, conducted an evaluation of our disclosure controls
and procedures, as defined under Exchange Act Rule 13a-15(e), as of the end of the period
covered by this Annual Report on Form 20-F. Based upon that evaluation, our chief
executive officer and chief financial officer concluded that our disclosure controls and
procedures were not effective at a reasonable level of assurance as of December 31, 2008,
in that we had insufficient personnel with appropriate level of knowledge, experience and
training in the application of generally accepted accounting principles commensurate with
our financial reporting requirements in our newly acquired European subsidiary.

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# Managements Report
on Internal Control over Financial Reporting

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

Our
management assessed the effectiveness of our internal control over financial reporting as
of December 31, 2008. In conducting its assessment of internal control over financial
reporting, management based its evaluation on the framework in Internal Control
 Integrated Framework issued by the Committee of Sponsoring Organizations, or
the COSO, of the Treadway Commission.

During
the fourth quarter of 2008, we experienced the following problems with our internal
control over financial reporting with respect to the recording of the financial results of
our new European subsidiary that we acquired in September 2007: certain revenues with
respect to certain projects in Africa that are reflected in the financial statements using
the percentage of completion basis of accounting were misvalued and the provision for
warranties and penalties with respect to these projects was under accrued. As a result, as
of December 31, 2008, we applied the completed contract method of accounting only with
respect to these projects, in order to provide adequate information. We performed
sufficient procedures to determine that all material errors were identified and corrected
before the company publicly reported its results of operations. We also concluded that
these errors in accounting and financial reporting reflect material weaknesses in internal
control over financial reporting resulting from insufficient personnel in the European
subsidiary with the appropriate level of knowledge, experience and training in the
application of generally accepted accounting principles commensurate with our financial
reporting requirements. Therefore, our management concluded that, as of December 31, 2008,
our internal control over financial reporting was not effective because of the material
weaknesses in internal control over financial reporting described above.

# Remediation of Material
Weaknesses

Under
the direction of our chief executive officer and chief financial officer and in
consultation with our audit committee, we have begun to implement measures to remediate
the effectiveness of our internal control over financial reporting. Since the beginning of
2009, we have appointed a new financial officer to the European subsidiary. In addition,
we are reexamining the design of the internal controls in the European subsidiary, as well
as implementing measures to appropriately staff and provide appropriate training to the
subsidiarys financial and accounting personnel. We believe that these measures, as
well as additional measures that are planned for 2009, will remediate the material
weakness of our internal control over financial reporting.

# Attestation Report of
Registered Public Accounting Firm

Kost
Forer Gabbay & Kasierer, a member of Ernst & Young Global, our independent
registered public accounting firm that audited our consolidated financial statements for
the year ended December 31, 2008 included in this annual report, has issued an attestation
report on our internal control over financial reporting. The report is included on page
F-3 of this annual report on Form 20-F.

81

---

---

# Changes in Internal
Control over Financial Reporting

There
were no changes in our internal control over financial reporting that occurred during the
period covered by this annual report that have materially affected, or that are reasonably
likely to materially affect, our internal control over financial reporting. However,
subsequent to December 31, 2008, we made changes to our internal control over financial
reporting and took remedial actions, as described above.

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

Our
board of directors has determined that Ms. Anat Winner, an independent director, meets the
definition of an audit committee financial expert, as defined by rules of the Securities
and Exchange Commission. For a brief description of Ms. 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 our 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
|--------- |  | --------------------------------------

# Independent Public
Accountant Fees and Services

The
following table sets forth, for each of the years indicated, the fees billed by 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
| | ------------- | ----------------------
|
|
|
|
| | Audit (1)     |                       
| | Audit-related |                       
| | Tax (2)       |                       
| | Other (3)     |                       
| |               |                       
| | Total         |                       

| | 
| | 

| | (1) | Audit
fees are for audit services for each of the years shown in the table, including fees
associated with the annual audit (including audit of our internal control over financial
reporting), consultations on various accounting issues and audit services provided in
connection with other statutory or regulatory filings.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Tax
fees are for professional services rendered by our auditors for tax
               compliance, tax planning and tax advice on actual or contemplated
transactions,                tax consulting associated to international taxation,
employee benefits, tax                assessment deliberation, and in connection with the
approval of our investment                program for our approved enterprise.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Other
fees relate to out of pocket reimbursement of expenses, primarily
               traveling expenses of our auditors.
| | --- | --------------------------------------------------------------------------------------------------------------------------

# 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.

82

---

---

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

Not
applicable.

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

Neither
we nor any affiliated purchaser has purchased any of our securities during 2008.

|ITEM 16F. |  | Changes In Registrants Certifying Accountant
|--------- |  | ---------------------------------------------

Not
applicable.

|ITEM 16G. |  | Corporate Governance
|--------- |  | --------------------

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

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

| |  | the
requirement regarding the process of nominating directors.  Instead, we follow Israeli
law and               practice in accordance with which our directors are recommended by
our board of directors for               election by our shareholders.  See Item 6.C.
"Directors, Senior Management and Employees - Board               Practices - Election of
Directors."
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
requirement regarding the compensation of our chief executive officer and all other
executive officers. Instead, we follow Israeli law and practice in accordance with which
our board of directors must approve all compensation arrangements for our chief executive
officer and all compensation arrangements for officers are subject to the chief executive
officers approval. See Item 6.C. Directors, Senior Management and Employees
 Compensation.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
requirement that our independent directors have regularly scheduled meetings at which
only independent directors are present. Under Israeli law independent directors are not
required to hold executive sessions.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
addition, on June 30, 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, under Israeli law and practice we are required to
appoint at least two external directors, within the meaning of the Israeli Companies Law,
to our board of directors. However, despite such notification of non-compliance, we
maintain a majority of independent directors.

# PART III

|ITEM 17. |  | Financial Statements
|-------- |  | --------------------

We
have elected to furnish financial statements and related information specified in Item 18.

83

---

---

|ITEM 18. |  | Financial Statements
|-------- |  | --------------------

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

# Consolidated Financial
Statements

|                                                                                    |            
|----------------------------------------------------------------------------------- | -----------
|
|
|
|
|Index to Financial Statements                                                       | F-1        
|                                                                                   
|Reports of Independent Registered Public Accounting Firm                            | F-2 - F-3  
|                                                                                   
|Consolidated Balance Sheets                                                         | F-4 - F-5  
|                                                                                   
|Consolidated Statements of Operations                                               | F-6        
|                                                                                   
|Statements of Changes in Shareholders' Equity                                       | F-7        
|                                                                                   
|Consolidated Statements of Cash Flows                                               | F-8 - F-9  
|                                                                                   
|Notes to Consolidated Financial Statements                                          | F-10 - F-45
|                                                                                   
|Reports of Independent Registered Public Accounting Firm with Respect to Subsidiary | F-46 - F-47
|                                                                                   
|Schedule of Valuation and Qualifying Accounts                                       | 86         

|ITEM 19. |  | Exhibits
|-------- |  | --------

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

|1.1 |  | Memorandum
of Association of the Registrant (1)
|--- |  | -----------------------------------------------

|1.2 |  | Articles
of Association of the Registrant (2)
|--- |  | ---------------------------------------------

|2.1 |  | Specimen
Share Certificate for Ordinary Share (3)
|--- |  | -------------------------------------------------

|2.2 |  | The
Registrant's Stock Option Plan (1993), as amended (4)
|--- |  | ---------------------------------------------------------

|8 |  | List
of Subsidiaries of the Registrant
|- |  | --------------------------------------

|12.1 |  | Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities
                 Exchange Act, as amended
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) under 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 |  | Consent
of Kost Forer Gabbay & Kasierer
|---- |  | ---------------------------------------

|15.2 |  | Consent
of Salles, Sainz - Grant Thornton, S. C. (relating to Senstar Stellar Latin America, S.
A. de C.V.)
|---- |  | -----------------------------------------------------------------------------------------------------------

---

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

84

---

---

|(2) | Filed
as an exhibit to our Registration Statement on Form F-1                (No. 33-57438),
filed with the Securities and Exchange Commission on                January 26, 1993, as
amended, and incorporated herein by reference, as amended                by an amendment
filed as an exhibit to our Registration Statement on Form S-8                (File No.
333-6246), filed with the Commission on January 7, 1997 and                incorporated
herein by reference, and as further amended by an amendment filed                as an
exhibit to our Annual Report on Form 20-F for the fiscal year ended
               December 31, 2000, filed with the Securities and Exchange Commission
on                June 29, 2001 and incorporated herein by reference.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Filed
as an exhibit to our Registration Statement on Form 8-A, filed with the
               Securities and Exchange Commission on March 18, 1993, as amended, and
               incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Filed
as an exhibit to our Registration Statement on Form S-8 (File No.
               333-6246), filed with the Securities and Exchange Commission on January 7,
1997                and incorporated herein by reference, as amended by an amendment
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.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

85

---

---

# MAGAL SECURITY SYSTEMS
LTD. AND ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL STATEMENTS

# AS OF DECEMBER 31, 2008

# IN U.S. DOLLARS

# INDEX

|                                                         | Page       
|-------------------------------------------------------- | -----------
|
|
|
|
|Reports of Independent Registered Public Accounting Firm | F-2 - F-3  
|                                                        
|Consolidated Balance Sheets                              | F-4 - F-5  
|                                                        
|Consolidated Statements of Operations                    | F-6        
|                                                        
|Statements of Changes in Shareholders' Equity            | F-7        
|                                                        
|Consolidated Statements of Cash Flows                    | F-8 - F-9  
|                                                        
|Notes to Consolidated Financial Statements               | F-10 - F-45
|                                                         |            



---

---

| |                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------
| | Kost Forer Gabbay & Kasierer3 Aminadav St.
Tel-Aviv 67067, Israel
Tel:  972 (3)6232525
Fax:  972 (3)5622555
www.ey.com/il

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Board of
Directors and 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, 2007 and 2008, and the
related consolidated statements of operations, changes in shareholders equity and
cash flows for each of the three years in the period ended December 31, 2008. 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 4% and 3.5% of total consolidated assets as of December 31, 2007 and 2008,
respectively, and whose revenues constitute approximately 11.1%, 9.4% and 4.9% of total
consolidated revenues for the years ended December 31, 2006, 2007 and 2008,
respectively. The financial statements of this company were audited by other auditors,
whose report has been furnished to us, and our opinion, insofar as it relates to amounts
included for this subsidiary, is based solely on the report of the other auditors.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. The audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits and the report of the other
auditors provide a reasonable basis for our opinion.

In
our opinion, based on our audits and the report of the other auditors, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of
December 31, 2007 and 2008, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended December 31, 2008, in
conformity with U.S. generally accepted accounting principles.

We
also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Companys internal control over financial
reporting as of December 31, 2008, based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated July 12, 2009 expressed an adverse opinion thereon.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|                 | /s/ Kost Forer Gabbay & Kasierer
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|July 12, 2009    | A Member of Ernst & Young Global
|                 |                                 

F - 2

---

---

| |                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------
| | Kost Forer Gabbay & Kasierer3 Aminadav St.
Tel-Aviv 67067, Israel
Tel:  972 (3)6232525
Fax:  972 (3)5622555
www.ey.com/il

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Board of
Directors and Shareholders of

# MAGAL SECURITY SYSTEMS
LTD.

We
have audited Magal Security Systems Ltd. (the Company) internal control over
financial reporting as of December 31, 2008, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). The Companys management is
responsible for maintaining effective internal control over financial reporting and for
its assessment of the effectiveness of internal control over financial reporting included
in the accompanying Managements Report on Internal Control over Financial Reporting.
Our responsibility is to express an opinion on the Companys internal control over
financial reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. Our audit included obtaining
an understanding of internal control over financial reporting, assessing the risk that a
material weakness exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A
companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted
accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements.

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

A material weakness is a deficiency,
or combination of deficiencies, in internal control over financial reporting, such that
there is a reasonable possibility that a material misstatement of the Companys
annual or interim financial statements will not be prevented or detected on a timely
basis. In its assessment management has identified material weaknesses at insufficient
personnel in the European subsidiary with the appropriate level of knowledge, experience
and training in the application of generally accepted accounting principles which resulted
in misevaluation of certain revenues with respect to certain projects in Africa that are
reflected in the financial statements using the percentage of completion basis of
accounting and the under accrual of the provision for warranties and penalties with
respect to these projects .This material weakness is considered in determining the nature,
timing and extent of audit tests applied in our audit of the 2008 financial statements,
and this report does not affect our report dated July 12, 2009 on those financial
statements.

In our opinion, because of the effect
of the material weaknesses described above on the achievement of the objectives of the
control criteria, the Company has not maintained effective internal control over financial
reporting as December 31, 2008, based on the COSO criteria.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|                 | /s/ Kost Forer Gabbay & Kasierer
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|July 12, 2009    | A Member of Ernst & Young Global

F - 3

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

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

|                                                                                  | December 31,
|--------------------------------------------------------------------------------- | ------------
|
|
|
|
|ASSETS                                                                            |             
|                                                                                  |             
|CURRENT ASSETS:                                                                   |             
|Cash and cash equivalents                                                         |             
|Marketable securities (Note 3)                                                    |             
|Short-term bank deposits                                                          |             
|Restricted deposit                                                                |             
|Trade receivables (net of allowance for doubtful accounts of $ 343 and $ 1,506 at |             
|December 31, 2007 and 2008, respectively)                                         |             
|Unbilled accounts receivable                                                      |             
|Other accounts receivable and prepaid expenses (Note 4)                           |             
|Deferred income taxes                                                             |             
|Inventories (Note 5)                                                              |             
|Costs incurred on long-term contracts (Note 2m)                                   |             
|                                                                                  |             
|                                                                                  |             
|Total current assets                                                              |             
|                                                                                  |             
|                                                                                  |             
|LONG-TERM INVESTMENTS AND RECEIVABLES:                                            |             
|Long-term trade receivables                                                       |             
|Long-term loan (Note 11h)                                                         |             
|Long-term bank deposits                                                           |             
|Escrow deposit (Note 1b)                                                          |             
|Severance pay fund                                                                |             
|                                                                                  |             
|                                                                                  |             
|Total long-term investments and receivables                                       |             
|                                                                                  |             
|                                                                                  |             
|PROPERTY AND EQUIPMENT, NET (Note 6)                                              |             
|                                                                                  |             
|                                                                                  |             
|DEFERRED INCOME TAXES                                                             |             
|                                                                                  |             
|                                                                                  |             
|OTHER INTANGIBLE ASSETS, NET (Note 7)                                             |             
|                                                                                  |             
|                                                                                  |             
|GOODWILL (Note 1b, 2l)                                                            |             
|                                                                                  |             
|                                                                                  |             
|ASSETS ATTRIBUTED TO DISCONTINUED OPERATIONS (Note 18)                            |             
|                                                                                  |             
|                                                                                  |             
|Total assets                                                                      |             
|                                                                                  |             
|                                                                                  |             

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

F - 4

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

|                                                           
|-----------------------------------------------------------
|CONSOLIDATED BALANCE SHEETS                                
|                                                           
|U.S. dollars in thousands (except share and per share data)

|                                                                          | December 31,
|------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                      |             
|                                                                          |             
|CURRENT LIABILITIES:                                                      |             
|Short-term bank credit (Note 8)                                           |             
|Current maturities of long-term bank debt (Note 10)                       |             
|Trade payables                                                            |             
|Customer advances                                                         |             
|Other accounts payable and accrued expenses (Note 9)                      |             
|                                                                          |             
|                                                                          |             
|Total current liabilities                                                 |             
|                                                                          |             
|                                                                          |             
|LONG-TERM LIABILITIES:                                                    |             
|Long-term bank debt (Note 10)                                             |             
|Deferred income taxes                                                     |             
|Accrued severance pay                                                     |             
|                                                                          |             
|                                                                          |             
|Total long-term liabilities                                               |             
|                                                                          |             
|                                                                          |             
|LIABILITIES ATTRIBUTED TO DISCONTINUED OPERATIONS (Note 18)               |             
|                                                                          |             
|                                                                          |             
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 11)                          |             
|                                                                          |             
|SHAREHOLDERS' EQUITY (Note 12):                                           |             
|Share capital -                                                           |             
|Ordinary shares of NIS 1 par value -                                      |             
|Authorized: 19,748,000 shares at December 31, 2007 and 2008; Issued and   |             
|outstanding: 10,396,548 shares at December 31, 2007 and 2008.             |             
|Additional paid-in capital                                                |             
|Accumulated other comprehensive income                                    |             
|Foreign currency translation (Company's stand alone financial statements) |             
|Retained earnings (accumulated deficit)                                   |             
|                                                                          |             
|                                                                          |             
|Total shareholders' equity                                                |             
|                                                                          |             
|                                                                          |             
|Total liabilities and shareholders' equity                                |             
|                                                                          |             
|                                                                          |             

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

F - 5

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

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

|                                                                       | Year ended December 31,
|---------------------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues                                                               |                        
|Cost of revenues                                                       |                        
|                                                                       |                        
|                                                                       |                        
|Gross profit                                                           |                        
|                                                                       |                        
|                                                                       |                        
|Operating expenses:                                                    |                        
|Research and development, net (Note 17a)                               |                        
|Selling and marketing, net                                             |                        
|General and administrative                                             |                        
|Impairment of goodwill and other intangible assets (Note 1)            |                        
|Post employment and termination benefits (Note 2t)                     |                        
|                                                                       |                        
|                                                                       |                        
|Total operating expenses                                               |                        
|                                                                       |                        
|                                                                       |                        
|Operating income (loss)                                                |                        
|Financial expenses, net (Note 17b)                                     |                        
|                                                                       |                        
|                                                                       |                        
|Income (loss) before income taxes                                      |                        
|Income taxes (Note 14)                                                 |                        
|                                                                       |                        
|                                                                       |                        
|Income (loss) from continuing operations                               |                        
|Income (loss) from discontinued operations, net (Note 18)              |                        
|                                                                       |                        
|                                                                       |                        
|Net income (loss)                                                      |                        
|                                                                       |                        
|                                                                       |                        
|Basic and diluted earnings (loss) per share from continuing operations |                        
|Basic and diluted earnings (loss) per share from discontinued          |                        
|operations                                                             |                        
|                                                                       |                        
|                                                                       |                        
|Basic earnings (loss) per share (Note 13)                              |                        
|                                                                       |                        
|                                                                       |                        

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

F - 6

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

|                                             
|---------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands (except share data)

|                                                                    | Number of
shares | Ordinary
shares | Additional
paid-in
Capital | Deferred
stock
compensation | Accumulated
other
comprehensive
income (loss) | Foreign
currency
translation
- the Company | Retained
earning
(accumulated
deficit) | Total
comprehensive
income (loss) | Total
shareholders'
equity
|------------------------------------------------------------------- | ---------------- | --------------- | -------------------------- | --------------------------- | --------------------------------------------- | ------------------------------------------ | -------------------------------------- | --------------------------------- | --------------------------
|
|
|
|
|Balance as of January 1, 2006                                       |                  |                 |                            | 10,372,448                  |                                               | $                                          | 3,220                                  |                                   | $                         
|Reclassification of deferred stock     compensation into            |                  |                
|additional paid-in capital upon       adoption of SFAS 123(R)       |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Stock-based compensation                                            |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Exercise of stock options                                           |                  |                 |                            | 19,100                      |                                               |                                            | 4                                      |                                   |                           
|Comprehensive income (loss):                                        |                  |                
|Net income                                                          |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Unrealized losses on forward     contracts, net                     |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Unrealized loss from available-for-sale                             |                  |                
|securities, net                                                     |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Foreign currency translation                                        |                  |                
|adjustments from change of        functional currency, net          |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Foreign currency translation        adjustments                     |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|Total comprehensive income                                          |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                
|Balance as of December 31, 2006                                     |                  |                 |                            | 10,391,548                  |                                               |                                            | 3,224                                  |                                   |                           
|Cumulative impact of change                                         |                  |                
|in accounting for uncertainty     in income taxes (Fin 48)          |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Stock-based compensation                                            |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|Exercise of stock options                                           |                  |                 |                            | 5,000                       |                                               |                                            | 1                                      |                                   |                           
|Comprehensive income (loss):                                        |                  |                
|Net income                                                          |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Unrealized gain on forward       contracts, net                     |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Unrealized loss from                                                |                  |                
|available-for-sale securities, net                                  |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Foreign currency translation       adjustments                      |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|Total comprehensive income                                          |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                
|Balance as of December 31, 2007                                     |                  |                 |                            | 10,396,548                  |                                               |                                            | 3,225                                  |                                   |                           
|Stock-based compensation                                            |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Comprehensive income (loss):                                        |                  |                
|Net loss                                                            |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Realized loss from available-for-sale       securities              |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|Foreign currency translation       adjustments                      |                  |                 |                            | -                           |                                               |                                            | -                                      |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|Total comprehensive loss                                            |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                
|Balance as of December 31, 2008                                     |                  |                 |                            | 10,396,548                  |                                               | $                                          | 3,225                                  |                                   | $                         
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                
|Accumulated foreign currency     translation adjustments            |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|Accumulated other comprehensive      income as of December 31, 2008 |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           
|                                                                    |                  |                 |                            |                             |                                               |                                            |                                        |                                   |                           

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

F - 7

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

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

|                                                                   | Year ended December 31,
|------------------------------------------------------------------ | -----------------------
|
|
|
|
|Cash flows from operating activities:                              |                        
|Net income (loss)                                                  |                        
|Adjustments required to reconcile net income (loss) to net cash    |                        
|provided by (used in) operating activities:                        |                        
|Loss (income) from discontinued operations                         |                        
|Depreciation and amortization                                      |                        
|Impairment of goodwill and other intangible assets                 |                        
|Gain on sale of property and equipment                             |                        
|Decrease (increase) in accrued interest and exchange differences   |                        
|on marketable securities, short-term and long-term bank deposits   |                        
|and long term loans                                                |                        
|Write off of long term loan                                        |                        
|Accrued interest and exchange rate changes of long-term loans      |                        
|Stock based compensation                                           |                        
|Losses (gains) on forward contract, net                            |                        
|Decrease (increase) in trade receivables, net                      |                        
|Decrease (increase) in unbilled accounts receivable                |                        
|Decrease (increase) in other accounts receivable and prepaid       |                        
|expenses                                                           |                        
|Decrease (increase) in deferred income taxes                       |                        
|Decrease (increase) in inventories                                 |                        
|Decrease (increase) in costs incurred on long-term contracts       |                        
|Decrease (increase) in long-term trade receivables                 |                        
|Increase (decrease) in trade payables                              |                        
|Increase (decrease) in other accounts payable and accrued expenses |                        
|Increase (decrease) in customer advances                           |                        
|Accrued severance pay, net                                         |                        
|                                                                   |                        
|                                                                   |                        
|Net cash provided by (used in) continuing operations               |                        
|Net cash provided by (used in) discontinued operations             |                        
|                                                                   |                        
|                                                                   |                        
|Net cash provided by (used in) operating activities                |                        
|                                                                   |                        
|                                                                   |                        
|Cash flows from investing activities:                              |                        
|Purchase of short-term deposits                                    |                        
|Investment in restricted deposit                                   |                        
|Proceeds from sale of short-term bank deposits                     |                        
|Escrow deposit                                                     |                        
|Purchase of long-term bank deposits                                |                        
|Proceeds from sale of long-term deposits                           |                        
|Purchase of marketable securities                                  |                        
|Proceeds from sale of marketable securities                        |                        
|Investment in long-term loan                                       |                        
|Proceeds from sale of property and equipment                       |                        
|Purchase of property and equipment                                 |                        
|Purchase of know-how and patents                                   |                        
|Acquisition of subsidiary (a)                                      |                        
|                                                                   |                        
|                                                                   |                        
|Net cash provided by (used in) continuing activities               |                        
|Net cash provided by (used in) discontinued operations             |                        
|                                                                   |                        
|                                                                   |                        
|Net cash provided by (used in) investing activities                |                        
|                                                                   |                        
|                                                                   |                        

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

F - 8

---

---

| | MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
| | ------------------------------------------------

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

|                                                                  | Year ended December 31,
|----------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from financing activities:                             |                        
|Short-term bank credit, net                                       |                        
|Proceeds from long-term bank loans                                |                        
|Principal payment of long-term bank loans                         |                        
|Proceeds from exercise of employee stock options                  |                        
|                                                                  |                        
|Net cash provided by (used in) financing activities               |                        
|                                                                  |                        
|                                                                  |                        
|Effect of exchange rate changes on cash and cash equivalents      |                        
|                                                                  |                        
|                                                                  |                        
|Increase (decrease) in cash and cash equivalents                  |                        
|Cash and cash equivalents at the beginning of the year            |                        
|                                                                  |                        
|                                                                  |                        
|Cash and cash equivalents at the end of the year                  |                        
|                                                                  |                        
|                                                                  |                        
|Supplemental disclosures of cash flows activities:                |                        
|                                                                  |                        
|Cash paid during the year for:                                    |                        
|Interest                                                          |                        
|                                                                  |                        
|                                                                  |                        
|Income taxes                                                      |                        
|                                                                  |                        
|                                                                  |                        
|Non-cash activities:                                              |                        
|Purchase of know-how                                              |                        
|                                                                  |                        
|                                                                  |                        
|Sale of marketable security to a former shareholder of subsidiary |                        
|(Note 1)                                                          |                        
|                                                                  |                        
|                                                                  |                        
|a. Acquisition of Subsidiary                                      |                        
|                                                                  |                        
|Fair value of assets acquired and liabilities assumed at date of  |                        
|acquisition;                                                      |                        
|                                                                  |                        
|Working capital, net                                              |                        
|Property and equipment                                            |                        
|Customer related intangible assets                                |                        
|Deferred taxes                                                    |                        
|Accrued severance pay                                             |                        
|                                                                  |                        
|                                                                  |                        
|                                                                  |                        
|                                                                  |                        
|                                                                  |                        

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

F - 9

---

---

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

# NOTE 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. The Groups systems are used in more than 75
countries around the                world.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
for major customer data, see Note 16b.
| | -----------------------------------------

| | b. | On
August 31, 2007, the Company entered into an agreement to purchase all of the
               shares of a European company engaged in the installation and integration
of                security systems (hereinafter  the European subsidiary), in
consideration                for 6,800 thousand Euros (approximately $ 9,300), of
which 3,000 thousand                Euros are payable upon compliance of certain
conditions. The 3,000 thousand                Euros were deposited in an escrow account
of which 2,400 thousand Euros was paid                during 2008 and recorded as
goodwill.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition to the 6,800 thousand Euros the Company will pay over the years 2007-2012 an
amount based on the European subsidiary pre tax income and will record such payments to
goodwill. During 2007, the Company incurred an amount of $ 1,065 in respect of the
earn out provision which was paid in 2008.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2008, the European subsidiary sold to its former owner $ 4,400 of marketable
securities of which $ 3,300 was paid as a set-off of future earn out payments and
$ 1,100 was paid on account of a payable accrued per the original consideration.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
financial statements of the European subsidiary have been consolidated with the
Companys financial statements from September 1, 2007, the date the transaction was
closed.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for using the purchase method of accounting as determined in
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations (SFAS No. 141) and, accordingly, the purchase price was
allocated to the assets acquired and liabilities assumed based on their estimated fair
values at the date of acquisition.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Based
upon an evaluation of the tangible and intangible assets acquired and liabilities assumed,
the Company allocated the total cost of the acquisition, as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                    | 
| | ---------------------------------- | 
|
|
|
|
| | Working capital, net               | 
| | Property and equipment             | 
| | Customer related intangible assets | 
| | Deferred taxes                     | 
| | Accrued severance pay, net         | 
| |                                    | 
| |                                    | 
| |                                    | 
| |                                    | 

F - 10

---

---

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

# NOTE 1:- GENERAL (Cont.)

| | In
accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS
No. 142), goodwill is not amortized. In lieu of amortization, the Company is
required to perform an annual impairment test. If the Company determines, through the
impairment test process, that goodwill has been impaired, it will record the impairment
charge in its statement of operations. The Company will also assess the impairment of
goodwill whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. Customer related intangible assets are reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS No. 144) by a comparison of the carrying amount
to the future undiscounted cash flows expected to be generated by the assets. If such
asset is considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the asset exceeds its fair value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2008, following the annual goodwill impairment test, the Company determined that the fair
value of its European subsidiary had decreased and, as a result recorded a goodwill
impairment charge of $ 8,423 (including $ 3,300 of funds prepaid on account of
future earn-out payments). In addition, the Company determined that intangible assets
attributable to customers of the European subsidiary in the amount of $ 1,692 had been
impaired, and as a result, recorded an impairment charge attributable to such intangible
assets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Due
to a decrease in the operating activities and slowdown in the business the
               Companys U.S. subsidiary, the Company determined that a goodwill
               impairment of $ 2,421 exists in respect of the U.S. subsidiary as of
December                31, 2008 and recorded an impairment charge accordingly.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 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 U.S. 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:
| | -- | -------------------------------------

| | The
Companys revenues are generated in NIS, U.S. dollars and Euro. In addition, most of
the Companys costs are incurred in NIS and Canadian dollars. The Companys
management believes that the NIS is the primary currency of the economic environment in
which the Company operates. Therefore, the functional currency of the Company is the NIS
and its reporting currency is the U.S. dollar.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
functional currency of the Companys foreign subsidiaries is the local currency in
which each subsidiary operates.
| | ----------------------------------------------------------------------------------------------------------------------

F - 11

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | SFAS
No. 52, Foreign Currency Translation sets the standards for translating
foreign currency financial statements of consolidated subsidiaries. The first step in the
translation process is to identify the functional currency for each entity included in the
financial statements. The accounts of each entity are then remeasured in its
functional currency. All transaction gains and losses from the remeasurement of monetary
balance sheet items are reflected in the statement of operations as financial income or
expenses, as appropriate.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | In
accordance with U.S. Securities and Exchange Commission Regulation S-X 3-20 (SX
3-20), the Company has determined its reporting currency to be the dollar. The
measurement process of Regulation S-X 3-20 is conceptually consistent with that of SFAS
52.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has determined that as of October 1, 2006 its functional currency changed from the
dollar to the New Israeli Shekel (NIS). Translation adjustments resulting from
translating the Companys financial statements from the NIS to the dollar are
reported as a separate component in shareholders equity.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Principles
of consolidation:
| | -- | ----------------------------

| | The
consolidated financial statements include the accounts of the Company and its
subsidiaries. Intercompany transactions and balances including profits from intercompany
sales not yet realized outside the 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Marketable
securities:
| | -- | ----------------------

| | The
Company accounts for investments in debt securities in accordance with SFAS 115,
Accounting for Certain Investments in Debt and Equity Securities (SFAS
115). Management determines the appropriate classification of its investments in
debt and equity securities at the time of purchase and reevaluates such determinations at
each balance sheet date. The debt securities are classified as
available-for-sale since the Company does not have the intent to hold the
securities to maturity, and are stated at fair value. Available-for-sale securities are
carried at fair value with unrealized gains, and losses as reported net of tax in
accumulated other comprehensive income as a separate component of shareholders
equity.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | The
Financial Accounting Standards Board (FASB) Staff Position (FSP) No. 115-1,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investment (FSP 115-1) and SAB Topic 5M Other Than Temporary
Impairment of Certain Investments In Debt and Equity Securities provides guidance
for determining when an investment is considered impaired, whether impairment is
other-than temporary, and measurement of an impairment loss. An investment is considered
impaired if the fair value of the investment decreased below its cost in an other-than
temporary manner. If, after consideration of all available evidence to evaluate the
realizable value of its investment, impairment is determined to be other than 
temporary, then an impairment loss should be recognized equal to the difference between
the investments cost and its fair value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Short-term
and long-term bank deposits:
| | -- | ---------------------------------------

| | Short-term
bank deposits are deposits with maturities of more than three months and less than one
year, and presented at their cost.
| | ------------------------------------------------------------------------------------------------------------------------------------

| | A
bank deposit with maturities of more than one year is included in long-term bank deposits,
and presented at cost.
| | -------------------------------------------------------------------------------------------------------------------

| | g. | Inventories:
| | -- | ------------

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

| | 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 costs, representing allocable operating overhead
expenses manufacturing costs.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2006, 2007 and 2008, the Group recorded inventory write-offs from continued operations in
the amount of $ 760 ,$ 646 and $ 2,041, respectively. Such write-offs were
included in cost of revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. | Long-term
trade receivables:
| | -- | ----------------------------

| | Long-term
trade and other receivables from extended payment agreements, are recorded at their
estimated present values.
| | -----------------------------------------------------------------------------------------------------------------------

F - 13

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | i. | Property
and equipment:
| | -- | -----------------------

| | Property
and equipment are stated at cost, net of accumulated depreciation. Depreciation is
calculated by the straight-line method over the estimated useful lives of the assets at
the following annual rates:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                | %                                     
| | ------------------------------ | --------------------------------------
|
|
|
|
| | Buildings                      | 3 - 4                                 
| | Machinery and equipment        | 10 - 33 (mainly 10%)                  
| | Motor vehicles                 | 15                                    
| | Promotional displays           | 25 - 50                               
| | Office furniture and equipment | 6 - 33                                
| | Leasehold improvements         | By the shorter of the term of the     
| |                                | lease or the useful life of the assets

| | j. | Intangible
assets:
| | -- | ------------------

| | Intangible
assets are amortized over their useful lives using a method of amortization that reflects
the pattern in which the economic benefits of the intangible assets are consumed or
otherwise used up, in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets (SFAS No. 142).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Know-how
is amortized over five to ten years, patents are amortized over a period of ten years and
technology is amortized over eight years. Customer related asset is amortized based on the
related revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. For 2006 and 2007, the Company did not record any impairment charges attributable
to long-lived assets. In 2008, the Company recorded an impairment charge of $ 2,043
attributable to such intangible assets.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | l. | Goodwill:
| | -- | ---------

| | Goodwill
represents excess of the costs over the net fair value of the assets of the businesses
acquired. SFAS No. 142 requires goodwill to be tested for impairment at least annually or
between annual tests in certain circumstances, and written down when impaired, rather than
being amortized. FAS 142 prescribes a two phase process for impairment testing of
goodwill. The first phase screens for impairment, while the second phase (if necessary)
measures impairment. In the first phase of impairment testing, 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. If the carrying value of the reporting unit
exceeds its fair value, the second phase is then performed. The second phase of the
goodwill impairment test compares the implied fair value of the reporting units
goodwill with the carrying amount of that goodwill. If the carrying amount of the
reporting units goodwill exceeds the implied fair value of that goodwill, an
impairment loss is recognized in an amount equal to that excess. 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. For 2006 and 2007, the Company
did not record any impairment charges. In 2008, the Company recorded an impairment charge
in the amount of $ 10,844.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Group generates its revenues mainly from (1) installation of comprehensive security
systems for which revenues are generated from long-term fixed price contracts; (2) sales
of security products; and (3) services and maintenance, which are performed either on a
fixed-price basis or as time-and-materials based contracts.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from installation of comprehensive security systems are generated from fixed-price
contracts according to which the time between the signing of the contract and the final
customer acceptance is usually over one year. Such contracts require significant
customization for each customer specific needs and, as such, revenues from these type of
contracts are recognized in accordance with Statement of Position (SOP) No.
81-1, Accounting for Performance of Construction-Type and Certain Production-Type
Contracts, using contract accounting on a percentage of completion method.
Accounting for long-term contracts using the percentage-of-completion method stipulates
that revenue and expense are recognized throughout the life of the contract, even though
the project is not completed and the purchaser does not have possession of the project.
Percentage of completion is calculated based on the Input Method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Project
costs include materials purchased to produce the system, related labor and overhead
expenses and subcontractors costs. The percentage to completion is measured by
monitoring costs and efforts devoted using records of actual costs incurred to date in the
project compared to the total estimated project requirement, which corresponds to the
costs related to earned revenues. The amounts of revenues recognized are based on the
total fees under the agreements and the percentage to completion achieved. Provisions for
estimated losses on uncompleted contracts are made in the period in which such losses are
first determined, in the amount of the estimated loss on the entire contract.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 15

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

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

| | Fees
are payable upon completion of agreed upon milestones and subject to customer acceptance.
Amounts of revenues recognized in advance of contractual billing, are recorded as unbilled
accounts receivable. The period between most instances of advanced recognition of revenues
and the customers billing generally ranges between one to six months.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Although
the Companys basic accounting policy is percentage-of-completion, the
completed-contract method is used for certain contracts when the Company cannot make
reasonably dependable estimates for such contracts due to inherent hazards. Inherent
hazards are conditions and events that do not occur in the normal course of business.
Under the completed-contract method, billings and costs are accumulated on the balance
sheet under the caption cost incurred on long-term contracts while the
contract is in progress, but no revenue is recognized until the contract is completed or
substantially completed. When revenues and costs are recognized based upon substantial
completion of the contract, an accrual is recorded for the estimated remaining costs to be
incurred and for the estimated amounts of any unresolved claims or disputes related to the
contract that are probable of payment. During 2008, the Company concluded that the
projects in Africa are not typical in comparison to its other projects and identified
inherent hazards related to these projects and delays in payments from the customer. The
above caused the Company to conclude in 2008 that it cannot make reasonably dependable
estimates to calculate the percentage of completion of these projects, therefore, the
Company applied from 2008 the completed-contracts method with respect to these projects.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group sells security products to customers according to customer orders without
installation work. The customers do not have a right to return the products. Revenues from
security product sales are recognized in accordance with Staff Accounting Bulletin
(SAB) No. 104, Revenue Recognition in Financial Statements, when
delivery has occurred, persuasive evidence of an agreement exists, the vendors fee
is fixed or determinable, no further obligation exists and collectibility is probable.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Services
and maintenance are performed under either fixed-price based or time-and-materials based
contracts. Under fixed-price contracts, the Group agrees to perform certain work for a
fixed price. Under time-and-materials contracts, the Group is reimbursed for labor hours
at negotiated hourly billing rates and for materials. Such service contracts are not in
the scope of SOP No. 81-1, and accordingly, related revenues are recognized in accordance
with SAB No. 104, as those services are performed or over the term of the related
agreements provided that, an evidence of an arrangement has been obtained, fees are fixed
and determinable and collectibility is reasonably assured.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 16

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | n. | Accounting
for stock-based compensation:
| | -- | ----------------------------------------

| | The
Company accounts for stock-based compensation in accordance with SFAS No. 123 (revised
2004), Share-Based Payment (SFAS 123(R)).
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
123(R) requires companies to estimate the fair value of equity-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as an expense over the requisite service periods
in the Companys consolidated income statement.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company recognizes compensation expenses for the value of its awards, which have graded
vesting, based on the accelerated attribution method over the vesting period, net of
estimated forfeitures. Estimated forfeitures are based on actual historical pre-vesting
forfeitures.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the years ended December 31, 2006, 2007 and 2008, the Company recognized stock-based
compensation expenses related to employee stock options in the amounts of $ 51,
$ 83 and $ 237, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company estimated the fair value of stock options granted using the Black-Scholes-Merton
option-pricing model for the years ended December 31, 2006 and 2007 and the Binomial Model
(Binomial Model) model thereafter. The fair value of the options was estimated
by applying the Binomial Model for option pricing with adjustments for employees stock
options and for the specific terms and conditions of the options. The Company believes
that a lattice model (such as the Binomial Model) is more appropriate fair valuation
technique in this case, because of its flexible construction that allows the Company to
represent its relevant experience more accurately than the closed-form models (such as
Black and Scholes model).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
during the year ended December 31, 2008 no expenses were recorded due to options granted
in prior years, but solely from those related to new awards granted in 2008, which were
measured using the binomial model, there is no impact on the net income or on the basic
and diluted net income per share and for the period ended December 31, 2008, as a result
of the change in the model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value for the Companys stock options granted to employees and directors was
estimated using the following weighted-average assumptions:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Black-Scholes option-pricing model requires a number of assumptions, of which the most
significant are expected stock price volatility and the expected option term. Expected
volatility was calculated based upon actual historical stock price movements. The expected
option term represents the period that the Companys stock options are expected to be
outstanding and was determined based on the simplified method permitted by SAB 107 and SAB
110 as the average of the vesting period and the contractual term. The risk-free interest
rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term to
the expected life of the options. The Company has historically not paid dividends and has
no foreseeable plans to pay dividends.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | The
following assumptions were used in the Black-Scholes pricing model for 2006 and 2007:
| | -----------------------------------------------------------------------------------------

| |                        | 2006 | 2007
| | ---------------------- | ---- | ----
|
|
|
|
| | Dividend yield         |      |     
| | Expected volatility    |      |     
| | Risk-free interest     |      |     
| | Expected life of up to |      |     
| | Forfeiture rate        |      |     

| | The
Binomial model for option pricing requires a number of assumptions, of which the most
significant are the suboptimal exercise factor and expected stock price volatility. The
suboptimal exercise factor is estimated using historical option exercise information. The
suboptimal exercise factor is the ratio by which the stock price must increase over the
exercise price before employees are expected to exercise their stock options. Expected
volatility is based upon actual historical stock price movements and was calculated as of
the grant dates for different periods, since the Binomial model can be used for different
expected volatilities for different periods. The risk-free interest rate is based on the
yield from U.S. Treasury zero-coupon bonds with an equivalent term to the contractual term
of the options.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following assumptions were used in the Binomial option pricing model for 2008:
| | ----------------------------------------------------------------------------------

| |                              | 2008
| | ---------------------------- | ----
|
|
|
|
| | Dividend yield               |     
| | Expected volatility          |     
| | Risk-free interest           |     
| | Contractual term             |     
| | Forfeiture rate              |     
| | Suboptimal exercise multiple |     

| | 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
credits.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. | Warranty
costs:
| | -- | ---------------

| | The
Group provides a warranty for up to 24 months, at no extra charge. The Group estimates the
costs that may be incurred under its warranty and records a liability in the amount of
such costs at the time product revenue is recognized in accordance with FASB
interpretation (FIN) No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others
and SFAS No. 5, Accounting for Contingencies. Factors that affect the
Groups warranty liability include the number of units, historical and anticipated
rates of warranty claims and cost per claim. The Group periodically assesses the adequacy
of its recorded warranty liabilities and adjusts the amounts as necessary. A tabular
reconciliation of the changes in the Groups aggregate product warranty liability is
not provided due to immateriality.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | q. | Net
earnings (loss) per share:
| | -- | ------------------------------

| | Basic
net earnings (loss) per share is computed based on the weighted average number of Ordinary
shares outstanding during each year. Diluted net earnings (loss) per share is computed
based on the weighted average number of Ordinary shares outstanding during each year, plus
dilutive potential Ordinary shares considered outstanding during the year, in accordance
with SFAS No. 128 , Earnings Per Share.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | r. | Concentrations
of credit risk:
| | -- | ------------------------------

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

| | Of
the Companys cash and cash equivalents, marketable securities and short-term and
long-term bank deposits at December 31, 2008, $14.6 million is invested in major Israeli
and U.S. banks, approximately $ 10.4 million is invested in other banks, mainly with
Deutsche Bank, RBC Royal Bank, Leutkircher Bank and Bank of Nova Scotia. Deposits, cash
and cash equivalents in the United States may be in excess of insured limits and are not
insured in other jurisdictions. Generally these deposits may be redeemed upon demand and,
therefore, bear low risk.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys marketable securities include investments in U.S. corporate bonds.
| | --------------------------------------------------------------------------------

| | The
short-term and long-term trade receivables of the Group, as well as the unbilled accounts
receivable, are primarily derived from sales to large and solid organizations and
governmental authorities located mainly in Israel, the United States, Canada, Mexico,
Africa and Europe. The Group performs ongoing credit evaluations of its customers and to
date has not experienced any material losses. An allowance for doubtful accounts is
determined with respect to those amounts that the Group has determined to be doubtful of
collection and in accordance with an aging policy. As of December 31, 2008, the
Companys allowance for doubtful accounts amounted to $ 1,506. During the years ended
December 31, 2006, 2007 and 2008, the Group recorded $ 138, $ (68) and
$ 1,223 of expenses (income) related to doubtful accounts, respectively. In certain
circumstances, the Group may require letters of credit, other collateral or additional
guarantees.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
loan granted to a third party is secured by a personal guarantee of the beneficial owner
of the third party, however, management anticipates difficulties in the full repayment of
the loan, (see Note 11h).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 w below.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | s. | 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2007, the Company adopted the provisions of FIN No. 48,
Accounting for Uncertainty in Income Taxes  an interpretation of FASB
Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for
uncertainties in income taxes by establishing minimum standards for the recognition and
measurement of tax positions taken or expected to be taken in a tax return. Under the
requirements of FIN 48, the Company must review all of its tax positions and make a
determination as to whether its position is more-likely-than-not to be sustained upon
examination by regulatory authorities. If a tax position meets the
more-likelythan-not standard, then the related tax benefit is measured based on a
cumulative probability analysis of the amount that is more-likely-than-not to be realized
upon ultimate settlement or disposition of the underlying issue. The impact on the
Companys consolidated financial position and results of operations as a result of
the adoption of the provisions of FIN 48 in 2007 was $ 229, which was recognized as
an adjustment to retained earnings. In 2008, the Company recorded tax benefit of $59.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | On
December 31, 2007, the former Chairman of the Companys Board of Directors,
(hereinafter  the retired Chairman) retired from his position. Pursuant to his
retirement agreement, the retired Chairman will be entitled to receive certain perquisites
from the Company for the rest of his life. As of December 31, 2008, the actuarial value of
these perquisites is estimated to be approximately $ 603. This provision was included as
part of accrued severance pay.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | On
November 10, 2008, the Companys former President and chief executive officer
(hereinafter  the retired CEO) resigned. The retirement agreement entered into with
the retired CEO in the amount of $ 1,645 included consideration for a non compete
undertaking as well as severance payments and other retirement related payments in
accordance with the retired CEOs retirement agreement and Israeli law. In addition,
in 2008, certain senior employees were entitled to termination benefits in the aggregate
amount $ 881 related to their respective retirement from the Company. In connection
with such terminations, the Company recorded an expense of $ 2,526 of which
$ 500 was paid in 2008 and the balance will be paid during the years 2009-2010.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
expenses for the years ended December 31, 2006, 2007 and 2008, amounted to approximately
$ 476, $ 1,020 and $ 3,135, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------

| | u. | Fair
value of financial instruments:
| | -- | ------------------------------------

| | The
following methods and assumptions were used by the Group in estimating its fair value
disclosures for financial instruments:
| | --------------------------------------------------------------------------------------------------------------------------------

| | (i) | The carrying amounts of cash and cash equivalents, marketable securities,
                    short-term bank deposits, trade receivables, unbilled accounts receivable,
                    short-term bank credit and trade payables approximate their fair value due to
                    the short-term maturity of such instruments.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | The carrying amount of the Groups long-term trade receivables and
                    long-term bank deposits approximate their fair value. The fair value was
                    estimated using discounted cash flows analysis, 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, 2008, the fair value of
                    the Companys long-term borrowing was $ 3,035 compared to the carrying
                    amount of $ 3,095.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Advertising
expenses:
| | -- | ---------------------

| | Advertising
costs are expensed as incurred. Advertising expenses for the years ended December 31,
2006, 2007 and 2008, were $ 447, $ 250 and $ 334, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | w. | 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | In
2006, the Company entered into forward contracts in order to hedge portions of its
forecasted revenue and unbilled accounts receivable denominated in Euros and Polish
Zlotys. The Company 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company determined that the sales arrangement in Polish Zlotys and the related forecasted
revenues and accounts receivable will not occur by the end of the specified time period.
Accordingly, changes in the fair value of the forward contracts were recorded in financial
expenses in the years ended December 31 2006 and 2007.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
October 1, 2006, the Company changed its functional currency from dollars to NIS (see also
Note 2b). From the date of the change of functional currency, hedges against the dollar
for revenues in Euros is no longer effective. Changes in the fair value of the forward
contracts from October 1, 2006 were charged to financial expenses.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
group recorded $ 915, $ 666 and $ 291 in financial expenses related to forward
contracts transactions, in 2006, 2007 and 2008, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

| | x. | Fair
value.
| | -- | -----------

| | The
carrying amount reported in the balance sheet for cash and cash equivalents, short-term
bank deposits, trade receivables, short-term bank credit and loans and trade payables
approximate their fair values due to the short-term maturities of such instruments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2008, the Company adopted SFAS 157 and effective October 10, 2008, the Company
adopted FSP No. SFAS 157-3, Determining the Fair Value of a Financial Asset when the
Market for that asset is not active, except as it applies to the nonfinancial assets and
nonfinancial liabilities subject to FSP 157-2. The Company chose to adopt the delay of the
effective date of SFAS 157 for one year for goodwill and customers related intangible
assets. SFAS 157 clarifies that fair value is an exit price, representing the amount that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. As such, fair value is a market-based measurement
that should be determined based on assumptions that market participants would use in
pricing an asset or a liability. As a basis for considering such assumptions, SFAS 157
establishes a three tier value hierarchy, which prioritizes the inputs used in the
valuation methodologies in measuring fair value:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Level 1 |  | Observable inputs that reflect quoted prices (unadjusted) for identical assets or
liabilities in active markets.
| | ------- | - | ----------------------------------------------------------------------------------------------------------------

| | Level 2 |  | Include other inputs that are directly or indirectly observable in the
marketplace.
| | ------- | - | -----------------------------------------------------------------------------------

| | Level 3 |  | Unobservable inputs which are supported by little or no market activity.
| | ------- | - | ------------------------------------------------------------------------

F - 22

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (CONT.)

| | The
fair value hierarchy also requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys marketable securities trade in markets that are considered to be active,
and are valued based on quoted market prices, broker or dealer quotations, or alternative
pricing sources with reasonable levels of price transparency and accordingly are
categorized as Level 1.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table presents assets and liabilities measured at fair value on a recurring
basis at December 31, 2008:
| | ---------------------------------------------------------------------------------------------------------------------

| |                               | Fair value measurements using input type
| | ----------------------------- | ----------------------------------------
|
|
|
|
| | Marketable securities:        |                                         
| |                               |                                         
| | Short-term available for sale |                                         
| | securities                    |                                         
| |                               |                                         
| | Total financial assets        |                                         

| | The
carrying amounts of financial instruments carried at cost, including cash and cash
equivalents, short-term bank deposits, trade receivables and trade payables approximate
their fair value due to the short-term maturities of such instruments.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | y. | Impact
of recently issued accounting standards:
| | -- | -----------------------------------------------

| | In
December 2007, the FASB issued SFAS 141(R), Business Combinations
(SFAS 141(R)). This Statement replaces SFAS No. 141, Business
Combinations, and requires an acquirer to recognize the assets acquired, the
liabilities assumed, including those arising from contractual contingencies, any
contingent consideration and any noncontrolling interest in the acquiree at the
acquisition date, measured at their fair values as of that date, with limited exceptions
specified in the statement. SFAS 141(R) also requires the acquirer in a business
combination achieved in stages (sometimes referred to as a step acquisition) to recognize
the identifiable assets and liabilities, as well as the noncontrolling interest in the
acquiree, at the full amounts of their fair values (or other amounts determined in
accordance with SFAS 141(R)). In addition, SFAS 141(R)s requirement to measure the
noncontrolling interest in the acquiree at fair value will result in recognizing the
goodwill attributable to the noncontrolling interest in addition to that attributable to
the acquirer. The impact of SFAS 141R on the Companys consolidated results of
operations will result in an adjustment to the income tax expenses, subsequent to the
effective date. The Company does not expect the adoption of SFAS 141(R) to have a material
impact on its consolidated financial position, results of operations and cash flows.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets (FSP 142-3). FSP 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under SFAS No. 142, Goodwill and Other
Intangible Assets. FSP 142-3 is effective for fiscal years beginning after December
15, 2008. The Company does not expect the adoption of FSP 142-3 to have a material impact
on its consolidated financial position, results of operations and cash flows.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | In
October 29, 2008, the FASB issued FSP FAS No.132 (R)-a, Employers Disclosures
about Pensions and Other Postretirement Benefits, to require that an employer
disclose the following information about the fair value of plan assets: 1) the level
within the fair value hierarchy in which fair value measurements of plan assets fall; 2)
information about the inputs and valuation techniques used to measure the fair value of
plan assets; and 3) a reconciliation of beginning and ending balances for fair value
measurements of plan assets using significant unobservable inputs. The FSP will be
effective for fiscal years ending after December 15, 2009, with early application
permitted. Application of the FSP will not be required for earlier periods that are
presented for comparative purposes. The Company is currently evaluating the potential
impact of adopting this FSP on its disclosures in the financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2009, the FASB issued FSP FAS No. 115-2 and SFAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments (the FSP). The FSP is intended to
provide greater clarity to investors about the credit and noncredit component of an
other-than-temporary impairment event and to more effectively communicate when an
other-than-temporary impairment event has occurred. The FSP applies to fixed maturity
securities only and requires separate display of losses related to credit deterioration
and losses related to other market factors. When an entity does not intend to sell the
security and it is more likely than not that an entity will not have to sell the security
before recovery of its cost basis, it must recognize the credit component of an
other-than-temporary impairment in earnings and the remaining portion in other
comprehensive income. upon adoption of the FSP, an entity will be required to record a
cumulative-effect adjustment as of the beginning of the period of adoption to reclassify
the noncredit component of a previously recognized other-than-temporary impairment from
retained earnings to accumulated other comprehensive income. The FSP will be effective for
the Company for the quarter ending June 30, 2009. The Company is currently evaluating the impact of
adopting the FSP.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2009, the FASB issued FSP FAS No. 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly (FSP 157-4). FSP 157-4 provides
additional authoritative guidance to assist both issuers and users of financial statements
in determining whether a market is active or inactive, and whether a transaction is
distressed. The FSP will be effective for us for the quarter ending June 30, 2009. The
Company does not expect the adoption of FSP 157-4 to have a material impact on its
consolidated financial position and results of operations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
November 2008, the EITF issued EITF Issue No. 08-7, Defensive Intangible
Assets (EITF 08-7), requires an acquiring entity to account defensive
intangible assets as a separate unit of accounting. Defensive intangible assets should not
be included as part of the cost of the acquirers existing intangible assets because
the defensive intangible assets are separately identifiable. Defensive intangible assets
must be recognized at fair value in accordance with SFAS 141(R) and SFAS 157. EITF 08-7
will be effective for the reporting period beginning after December 15, 2008. The Company
does not expect the adoption of EITF 08-7 to have a material impact on its consolidated
financial statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---

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

# NOTE 3:- MARKETABLE
SECURITIES

| | The
Group invests in marketable debt securities, which are classified as available-for-sale
investments. The following is a summary of marketable debt securities:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                            | December 31,
| | -------------------------- | ------------
|
|
|
|
| | Available-for-sale:        |             
| |                            |             
| | U.S. Government debentures |             
| | Corporate debt             |             
| |                            |             
| |                            |             
| | Total available-for-sale   |             
| | marketable securities      |             
| |                            |             

| | The
unrealized losses on available-for-sale securities included in other comprehensive
income, as a separate component of shareholders equity, totaled $ 134 and $ 0
as of December 31, 2007 and 2008, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, the Company recognized an impairment loss of $ 315 related to
other than temporary impairment of securities that were subsequently sold in February
2009.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amortized cost and estimated fair value of available-for-sale investments as of December
31, 2007 and 2008, by contractual maturity, are as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |                               | December 31,
| | ----------------------------- | ------------
|
|
|
|
| | Available-for-sale:           |             
| | Matures in one year           |             
| | Matures in one to three years |             
| |                               |             
| |                               |             
| |                               |             
| |                               |             

# NOTE 4:- OTHER ACCOUNTS
RECEIVABLE AND PREPAID EXPENSES

| |                        | December 31,
| | ---------------------- | ------------
|
|
|
|
| | Government authorities |             
| | Employees              |             
| | Prepaid expenses       |             
| | Advances to suppliers  |             
| | Others                 |             
| |                        |             
| |                        |             
| |                        |             
| |                        |             

F - 25

---

---

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

# NOTE 5:- INVENTORIES

| |                   | December 31,
| | ----------------- | ------------
|
|
|
|
| | Raw materials     |             
| | Work in progress  |             
| | Finished products |             
| |                   |             
| |                   |             
| |                   |             
| |                   |             

# NOTE 6:- PROPERTY AND
EQUIPMENT

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

| |                                |  | December 31,
| | ------------------------------ |  | ------------
|
|
|
|
| | Cost:                          |  |             
| | Land and buildings *)          |  |             
| | Machinery and equipment        |  |             
| | Motor vehicles                 |  |             
| | Promotional displays           |  |             
| | Office furniture and equipment |  |             
| | Leasehold improvements         |  |             
| |                                |  |             
| |                                |  |             
| |                                |  |             
| |                                |  |             
| | Accumulated depreciation:      |  |             
| | Buildings                      |  |             
| | Machinery and equipment        |  |             
| | Motor vehicles                 |  |             
| | Promotional displays           |  |             
| | Office furniture and equipment |  |             
| | Leasehold improvements         |  |             
| |                                |  |             
| |                                |  |             
| |                                |  |             
| |                                |  |             
| |                                |  |             
| | Property and equipment, net    |  |             
| |                                |  |             

| | b. | Depreciation expenses amounted to $ 1,053, $ 1,027 and $ 1,092
               for the years ended December 31, 2006, 2007 and 2008, respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | For
charges, see Note 11g.
| | -- | --------------------------

| | *) | The Company pledged a deposit of $ 1,800 as a guarantee for a building of its
               subsidiary in the United States.
| | -- | -----------------------------------------------------------------------------------------------------------------------------

F - 26

---

---

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

# NOTE 7:- OTHER
INTANGIBLE ASSETS, NET

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

| |                           |  | December 31,
| | ------------------------- |  | ------------
|
|
|
|
| | Cost:                     |  |             
| | Know-how                  |  |             
| | Patents                   |  |             
| | Customer related assets   |  |             
| | Technology                |  |             
| |                           |  |             
| |                           |  |             
| |                           |  |             
| |                           |  |             
| | Accumulated amortization: |  |             
| | Know-how                  |  |             
| | Patents                   |  |             
| | Customer related assets   |  |             
| | Technology                |  |             
| |                           |  |             
| |                           |  |             
| |                           |  |             
| |                           |  |             
| |                           |  |             
| | Other intangibles, net    |  |             
| |                           |  |             

| | b. | Amortization expenses related to intangible assets amounted to $ 150,
               $ 1,028 and $ 4,014 for the years ended December 31, 2006, 2007
               and 2008, respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amortization expenses include impairment of customer related assets and know-how in the
amount of $ 1,692 and $ 351, respectively, for the year ended December 31, 2008.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | December 31, | 
| | ------------ | 
|
|
|
|
| | 2009         | 
| | 2010         | 
| | 2011         | 
| | 2012         | 
| |              | 
| |              | 
| |              | 
| |              | 

F - 27

---

---

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

# NOTE 8:- SHORT-TERM BANK
CREDIT

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

| |                                    | Interest rate | December 31,
| | ---------------------------------- | ------------- | ------------
|
|
|
|
| | In or linked to U.S. dollars       |               |             
| | In or linked to NIS                |               |             
| | In or linked to EURO               |               |             
| | In or linked to Canadian dollar    |               |             
| |                                    |               |             
| |                                    |               |             
| |                                    |               |             
| |                                    |               |             
| | Weighted average interest rates at |               |             
| | the end of the year                |               |             

| | b. | Credit
lines
| | -- | ------------

| |                                     |  |  |  |  |  |  |  |  |   |        |  |   |        | 
| | ----------------------------------- |  |  |  |  |  |  |  |  | - | ------ |  | - | ------ | 
| | Short-term bank credit              |  |  |  |  |  |  |  |  | $ | 16,434 |  | $ | 23,182 | 
| | Long-term bank credit               |  |  |  |  |  |  |  |  |   | 7,398  |  |   | 3,095  | 
| | Performance guarantees              |  |  |  |  |  |  |  |  |   | 9,753  |  |   | 11,350 | 
| | Letters of credit                   |  |  |  |  |  |  |  |  |   | 1,202  |  |   | -      | 
| |                                     |  |  |  |  |  |  |  | 
| |                                     |  | 
| |                                     |  |  |  |  |  |  |  |  |   | 34,787 |  |   | 37,627 | 
| |                                     |  |  |  |  |  |  |  | 
| |                                     |  | 
| | Unutilized credit lines approximate |  |  |  |  |  |  |  |  |   | 28,801 |  |   | 24,264 | 
| |                                     |  |  |  |  |  |  |  | 
| |                                     |  | 
| | Total authorized credit lines       |  | 
| | approximate                         |  |  |  |  |  |  |  |  | $ | 63,588 |  | $ | 61,891 | 
| |                                     |  |  |  |  |  |  |  | 

| | c. | The Companys Canadian subsidiary has undertaken to maintain general
               covenants and the following financial ratios and terms in respect of its
               outstanding credit lines: a quick ratio of not less than 1.25; a ratio of total
               liabilities to tangible net worth of not greater than 0.75; and tangible net
               worth of at least $9.0 million As of December 31, 2008, the Companys
               subsidiary was in compliance with the ratios and terms.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | For charges, see Note 11g.
| | -- | --------------------------

# NOTE 9:- OTHER ACCOUNTS
PAYABLE AND ACCRUED EXPENSES

| |                                | December 31,
| | ------------------------------ | ------------
|
|
|
|
| | Employees and payroll accruals |             
| | Accrued expenses               |             
| | Deferred revenues              |             
| | Government authorities         |             
| | Income tax payable             |             
| | Others                         |             
| |                                |             
| |                                |             
| |                                |             
| |                                |             

F - 28

---

---

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

# NOTE 10:- LONG-TERM BANK
DEBT

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

| |                           | Linkage
terms | Interest rate | December 31,
| | ------------------------- | ------------- | ------------- | ------------
|
|
|
|
| | Bank loans                |               |               |             
| | Bank promissory notes     |               |               |             
| | Mortgage payable          |               |               |             
| |                           |               |               |             
| |                           |               |              
| |                           |               |               |             
| | Less - current maturities |               |               |             
| |                           |               |               |             
| |                           |               |              
| |                           |               |               |             
| |                           |               |               |             
| | Weighted average          |               |              
| | interest rates at the     |               |              
| | end of the year           |               |               |             

| | b. | As of December 31, 2008, the aggregate annual maturities of the long-term loans
               are as follows:
| | -- | --------------------------------------------------------------------------------------------------------------

| |      | 
| | ---- | 
|
|
|
|
| | 2009 | 
| | 2010 | 
| | 2011 | 
| |      | 
| |      | 
| |      | 
| |      | 

| | c. | As
for charges, see Note 11g.
| | -- | -----------------------------

# NOTE 11:- COMMITMENTS
AND CONTINGENT LIABILITIES

| | a. | Royalty commitments to the Office of the Chief Scientist of the Israeli Ministry
               of Industry and Trade (OCS):
| | -- | ------------------------------------------------------------------------------------------------------------------------------

| | Under
the research and development agreements between the Company and the OCS and pursuant to
applicable laws, the Company is required to pay royalties at the rate of 3%-4.5% of
revenues derived from sales of products developed with funds provided by the OCS and
ancillary services, 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 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 $ 79, $ 143 and $ 125 for the years ended
December 31, 2006, 2007 and 2008, respectively. As of December 31, 2008, the Company had
remaining contingent obligations to pay royalties in the amount of approximately
$ 1,365.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---

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

# NOTE 11:- COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)

| | b. | Royalty
commitments to a 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 defined formula. 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, 2008, royalty commitments under the agreement amounted
to $ 53.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | In September 2006, the Company signed a non exclusive agreement with a third
               party for the rights to use certain intangible assets such as know-how and
               patents for the production, sale and marketing of a perimeter security system
               based on fiber-optic lines that is used mainly to protect marine sites. The
               contract period is two years and the Company has the right to extend the
               contract for an additional five years. In September 2008, the management decided
               to extend the option. The consideration for the license is $ 548, payable in 24
               monthly installments. In addition, the Company agreed to pay royalties based on
               a defined formula. As of December 31, 2008, the Company recorded an impairment
               charge attributable to know how of $ 351.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the parties have signed an unlimited agreement that grants the Company the
rights to provide maintenance and support for the systems previously sold by the third
party. The Company agreed to pay royalties based on a defined formula. No royalties were
paid or accrued as of December 31, 2008.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Lease
commitments:
| | -- | ------------------

| | The
Group rents certain of its facilities and some of its motor vehicles under various
operating lease agreements, which expire on various dates, the latest of which is in 2011.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Future
minimum lease payments under non-cancelable operating lease agreements are as follows:
| | ---------------------------------------------------------------------------------------------

| |                     | 
| | ------------------- | 
|
|
|
|
| | 2009                | 
| | 2010                | 
| | 2011                | 
| | 2012 and thereafter | 
| |                     | 
| |                     | 
| |                     | 

| | Total
rent expenses for the years ended December 31, 2006, 2007 and 2008, were approximately
$ 700, $ 664 and $ 876 respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | e. | Guarantees:
| | -- | -----------

| | As
of December 31, 2008, the Group obtained bank performance guarantees and advance payment
guarantees and bid bond guarantees from several banks mainly in Israel in the aggregate
amount of $ 11,350.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 11:- COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)

| | f. | Legal
proceedings:
| | -- | ------------------

| | In
May 2005, the Company entered into an agreement to supply comprehensive security
solutions for a sensitive site in Eastern Europe. As part of the agreement, the Company
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, the Company
issued to the customer a performance bank guarantee. The Company commenced the project
and delivered some of the equipment and other deliverables to the customer in 2005. In
April 2006, the customer informed the Company that it was canceling the agreement due to
errors in the design documents that the Company submitted. In addition, the customer did
not make payments required under the agreement. Based on its cancellation of the
agreement, the customer collected $ 3,200 under the performance bank guarantee on
June 20, 2006. Due to this uncertainty, the Company did not recognize any revenues from
this project.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 11, 2006, the customer made a demand for an additional $ 1,400 payment under the
performance bank guarantee. Upon the Companys motion, the District Court in Haifa,
Israel issued a temporary injunction against the payment of such guarantee pending a
hearing in August 2006. At the hearing, the Company reached a settlement with the
customer pursuant to which the Company paid the customer approximately $ 700 of the
disputed amount and agreed that the balance would be repaid only if the Company is found
liable for damages exceeding the amount paid by it. In view of the above and due to the
uncertainty of the Company being able to prevent the forfeiture of the performance bank
guarantee, the Company included a $ 1,400 provision in respect of this guarantee in
its financial statements for the year ended December 31, 2005. Based on the August
2006 settlement, in 2006, the Company cancelled the balance of the provision it made in
its financial statements.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June 6, 2007, the Court of Arbitration issued its decision in the arbitration and stated
that the agreement concluded between the Company and the customer was void due to legal
mistakes made by the customer in the tender process. As a result of such award and as
agreed in the settlement agreement the performance guarantee was cancelled in February
2008. Based on the above the Company decided to institute a new legal action against the
customer and seek compensation for the damages incurred. The Company initiated the
following motions: (1) on December 10, 2007 a motion for reconciliation was submitted to
a Public Court; and (2) on December 11, 2007 a claim for compensation was submitted to
the Court of Arbitration. In both actions the claim was in the amount of $ 21,534.
In February 2008, the customer denied our request for reconciliation and as a result this
process was concluded. The arbitration proceeding is still pending.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Group is subject to legal proceedings arising in the normal course of
business. Based on the advice of legal counsel, management believes that these
proceedings will not have a material adverse effect on the Companys financial
position or results of operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | g. | Charges:
| | -- | --------

| | As
collateral for all of the Group liabilities to banks:
| | --------------------------------------------------------

| | 1. | A
fixed charge has been placed on the property of the Companys subsidiary in the United
          States.
| | -- | ----------------------------------------------------------------------------------------------------------

| | 2. | The
Company agreed not to pledge any of its assets without the consent of           certain
banks.
| | -- | --------------------------------------------------------------------------------------------------

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 11:- COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)

| | h. | In
October 2006, the Company signed an agreement with a third party, who
                    consults, markets and implements projects in the security field.
According to                     the agreement, during the first 12 months (the
agreement period),                     the parties agreed to cooperate in the
development of the business of the third                     party.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company granted a loan to the third party in the amount of $ 600. The Company also agreed
to provide the third party with additional monthly amounts to fund its activities during
the agreement period, that will not exceed $ 23 per month. The loan and the monthly
amounts will bear an annual interest rate of 5% and will be repaid in October 2011.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company received an option to purchase all of the assets of the third partys
business, exercisable during the agreement period (the option) until October
2008. The Company was obligated to exercise the option if the third party met certain
milestones. The exercise price of the option was comprised of the outstanding loan and
the monthly amounts mentioned above and an additional $ 400 in cash. In the event that
the Company had elected to exercise the option, the beneficial owner of the third party
would have been entitled to receive 50% of the operating profit of certain projects, as
defined in the agreement. As of December, 31 2008, the option expired.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company evaluated the anticipated repayment of the loan and due to anticipated
difficulties in the implementation of the projects management estimated that 50% of the
loan would not be repaid and therefore recorded a provision of $ 550.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 12:-
SHAREHOLDERS EQUITY

| | a. | Pertinent
rights and privileges conferred by Ordinary shares:
| | -- | -------------------------------------------------------------

| | The
Ordinary shares of the Company are listed on the NASDAQ Global Market and 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. | 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 may 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 also has the authority
to determine the vesting schedule and exercise price of options, granted under the 2003
Plan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
2003 Plan is effective for ten years and will terminate in October 2013. Any options that
are cancelled or forfeited before expiration become available for future grant.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2008, the Board of Directors approved an amendment to the 2003 Plan, which was
approved by the shareholders in August 2008, in accordance with which the number of Ordinary
shares available for issuance under the 2003 Plan increased by an additional 1,000,000
Ordinary shares and the termination of the 2003 Plan was extended from October 2013 to October
2018.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, 894,075 Ordinary shares were available for future option grants
under the 2003 Plan.
| | -------------------------------------------------------------------------------------------------------------

F - 32

---

---

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

# NOTE 12:-
SHAREHOLDERS EQUITY (Cont.)

| | A
summary of employee option activity under the Companys stock option plans as of
December 31, 2008 and changes during the year ended December 31, 2008 are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                         | Number of
options | Weighted-average
exercise
price | Weighted-
average
remaining
contractual
life
(in months | Aggregate
intrinsic
value (in
thousands)
| | --------------------------------------- | ----------------- | ------------------------------- | ------------------------------------------------------- | ----------------------------------------
|
|
|
|
| | Outstanding at January 1, 2008          |                   |                                 |                                                         | 403,500                                 
| | Granted                                 |                   |                                 |                                                         | 430,000                                 
| | Exercised                               |                   |                                 |                                                         | -                                       
| | Forfeited                               |                   |                                 |                                                         | (109,000                                
| |                                         |                   |                                 |                                                         |                                         
| |                                         |                   |                                
| | Outstanding at December 31, 2008        |                   |                                 |                                                         | 724,500                                 
| |                                         |                   |                                 |                                                         |                                         
| |                                         |                   |                                
| | Vested and expected to vest at December |                   |                                
| | 31, 2008                                |                   |                                 |                                                         | 704,500                                 
| |                                         |                   |                                 |                                                         |                                         
| |                                         |                   |                                
| | Exercisable at December 31, 2008        |                   |                                 |                                                         | 294,500                                 
| |                                         |                   |                                 |                                                         |                                         

| | The
weighted-average grant-date fair value of options granted during the years ended December 31,
2007 and 2008 was $ 3.94 and $ 2.84 respectively. The aggregate intrinsic value in the
table above represents the total intrinsic value (the difference between the Companys
closing stock price on the last trading day of the fourth quarter of fiscal 2008 and the
exercise price, multiplied by the number of in-the-money options). This amount changes
based on the fair market value of the Companys stock. Total intrinsic value of
options exercised for the year ended December 31, 2008 was $ 0, as none of the
options were exercised in the aforementioned period. As of December 31, 2008, there was
approximately $ 945 of total unrecognized compensation costs related to non-vested
share-based compensation arrangements granted under the Companys stock option
plans. This cost is expected to be recognized over a weighted-average period of 3.64
years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
options outstanding as of December 31, 2008 are follows:
| | ------------------------------------------------------------

| | Options outstanding
as of
December 31, 2008 | Exercise
price | Weighted
average
remaining
contractual
life | Options
exercisable
as of
December 31,
2008
| | ------------------------------------------- | -------------- | ------------------------------------------- | -------------------------------------------
|
|
|
|
| |                                             |                |                                             | 94,500                                     
| |                                             |                |                                             | 195,000                                    
| |                                             |                |                                             | 5,000                                      
| |                                             |                |                                             | 100,000                                    
| |                                             |                |                                             | 30,000                                     
| |                                             |                |                                             | 300,000                                    
| |                                             |                |                                             |                                            
| |                                             |               
| |                                             |                |                                             | 724,500                                    
| |                                             |                |                                             |                                            

F - 33

---

---

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

# NOTE 12:-
SHAREHOLDERS EQUITY (Cont.)

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

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

# NOTE 13:- BASIC AND
DILUTED NET EARNINGS PER SHARE

| |                                                           | Year ended December 31,
| | --------------------------------------------------------- | -----------------------
|
|
|
|
| | Numerator:                                                |                        
| |                                                           |                        
| | Income (loss) from continuing operations                  |                        
| | Income (loss) on discontinued operations                  |                        
| |                                                           |                        
| |                                                           |                        
| | Net income (loss)                                         |                        
| |                                                           |                        
| |                                                           |                        
| | Denominator:                                              |                        
| |                                                           |                        
| | Denominator for basic net earnings per share              |                        
| | weighted-average number of shares outstanding             |                        
| | Effect of diluting securities:                            |                        
| | Employee stock options                                    |                        
| |                                                           |                        
| |                                                           |                        
| | Denominator for diluted net earnings per share - adjusted |                        
| | weighted average shares and assumed exercises             |                        
| |                                                           |                        
| |                                                           |                        
| | Basic net earnings (loss) per share from continuing       |                        
| | operations                                                |                        
| | Basic net earnings (loss) per share from discontinued     |                        
| | operations                                                |                        
| |                                                           |                        
| |                                                           |                        
| | Basic net earnings (loss) per share                       |                        
| |                                                           |                        
| |                                                           |                        
| | Diluted net earnings (loss) per share from continuing     |                        
| | operations                                                |                        
| | Diluted net earnings (loss) per share from discontinued   |                        
| | operations                                                |                        
| |                                                           |                        
| |                                                           |                        
| | Diluted net earnings (loss) per share                     |                        
| |                                                           |                        

F - 34

---

---

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

# NOTE 14:- TAXES ON INCOME

| | a. | Tax
benefits in Israel under the Law for the Encouragement of Capital           Investments,
1959 (the Law):
| | -- | --------------------------------------------------------------------------------------------------------------

| | The
Company has been granted the status of an Approved Enterprise under the Law.
Currently, there are two expansion programs under which the Company is entitled to tax
benefits:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | On
March 18, 1997, a program of the Company was granted the status of an           Approved
Enterprise. The Company elected to enjoy the           alternative benefits track
 waiver of grants in return for a           tax exemption. 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           10%-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 terminated in 2007.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
August 13, 2002, another 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           10%-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
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 (The
years limitation). The years limitation does not apply to the
exemption period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
amendment to the Law, which was published effective as of April 1, 2005 (the
Amendment), changed certain provisions of the Law. As a result of the Amendment, a
company is no longer obliged to acquire Approved Enterprise status in order to
receive the tax benefits previously available under the alternative benefits provisions,
and therefore generally 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 entitled 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, referred to as a Beneficiary Enterprise. 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 seven years from the
Commencement Year, or 12 years from the first day of the Year of Election.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---

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

# NOTE 14:- TAXES ON
INCOME (Cont.)

| | On
March 3, 2007, the Company received a pre-ruling from the Israeli Tax Authority for its
request for a Beneficiary Enterprise, regarding eligibility for benefits under the
Amendment. The Companys income from this program is tax-exempt for a period of two
years, and is subject to a reduced tax rate of 10%-25% for a period of five to eight
years (depending upon the percentage of foreign ownership of the Company). The Company
has not yet obtained any tax benefits from this program.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Income
from sources other than an Approved Enterprise during the benefit period was
subject to tax at regular rate of 27% in 2008 (see e. below).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | By
virtue of the Law, the Company is entitled to claim accelerated depreciation on equipment
used by the Approved Enterprise during five tax years.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
the Company is operating under more than one approval for an Approved Enterprise and
since part of its taxable income is not entitled to tax benefits under the Law and is
taxed at regular rates (27% in 2008), its effective tax rate is the result of a weighted
combination of the various applicable rates and tax-exemptions. The computation is made
for income derived from each program on the basis of formulas determined in the law and
in the approvals.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
tax-exempt income attributable to the Approved Enterprises can be distributed
to shareholders without subjecting the Company to taxes only upon the complete
liquidation of the Company. If the retained tax-exempt income is distributed in a manner
other than in the complete liquidation of the Company, it would be taxed at the corporate
tax rate applicable to such profits as if the Company had not chosen the alternative tax
benefits (currently  15%).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys Board of Directors has decided that its policy is not to declare dividends
out of such tax-exempt income. Accordingly, no deferred income taxes have been provided
on income attributable to the companies. Approved Enterprises and Beneficiary
Enterprise, as such retained earnings are essentially permanent in duration.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 through 2006, the Company elected to measure
its taxable income and file its tax returns 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
election obligated the Company for three years. Accordingly, commencing in the 2003
taxable year, results for tax purposes are measured in terms of earnings in dollar.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---

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

# NOTE 14:- TAXES ON
INCOME (Cont.)

| | Changes
in the tax laws applicable to the Group:
| | ------------------------------------------------

| | In
February 2008, the Knesset (Israeli Parliament) passed an amendment to the
Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law with
effect from 2008 and thereafter. From 2008, the results for tax purposes will be measured
in nominal values, excluding certain adjustments for changes in the Israeli CPI carried
out in the period up to December 31, 2007. The amended law includes, among other things,
the elimination of the inflationary additions and deductions and the additional deduction
for depreciation with effect from 2008.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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%.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
an additional amendment to the Tax Ordinance, which came into effect on January 1, 2009,
an Israeli corporation may elect a 5% rate of corporate tax (instead of 25%) for income
from dividend distributions received from a foreign subsidiary which is used in Israel in
2009, or within one year after actual receipt of the dividend, whichever is later. The 5%
tax rate is subject to various conditions, which include conditions with regard to the
identity of the corporation that distributes the dividends, the source of the dividend,
the nature of the use of the dividend income, and the period during which the dividend
income will be used in Israel.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
tax rates of the Companys subsidiaries range between 16%-40%. In           December
2007, the tax rate in Germany was reduced to 30% from 38%. The tax           reduction is
effective beginning January 1, 2008. Deferred taxes had been           adjustment
according.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Investment
tax credit:
| | -- | ----------------------

| | Two
of the Companys subsidiaries are eligible for investment tax credits on their
research and development activities and on certain current and capital expenditures.
During the year ended December 31, 2008, the subsidiaries recognized $ 234 of
investment tax credits as a reduction of research and development expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
total, the subsidiaries have investment tax credits available to reduce future federal
income taxes payable, amounting to $ 706, which will expire in 2019-2028.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---

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

# NOTE 14:- 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,
| | -------------------------------------------------- | -----------------------
|
|
|
|
| | Income (loss) before taxes as reported in the      |                        
| | statements of operations                           |                        
| |                                                    |                        
| |                                                    |                        
| | Tax rate                                           |                        
| |                                                    |                        
| |                                                    |                        
| | Theoretical tax expense (tax benefit)              |                        
| | Increase (decrease) in taxes:                      |                        
| | Non-deductible items, net                          |                        
| | Difference due to the basis of measurement of      |                        
| | income reported for tax                            |                        
| | Deferred taxes on losses for which valuation       |                        
| | allowance was provided                             |                        
| | Tax exemption applicable to "Approved              |                        
| | Enterprises" and exempted income                   |                        
| | Reduction and tax rate differences in              |                        
| | subsidiaries                                       |                        
| | Taxes in respect of prior years                    |                        
| | Tax benefit due to discontinued operations         |                        
| | Other                                              |                        
| |                                                    |                        
| |                                                    |                        
| | Taxes on income (tax benefit) in the statements of |                        
| | operations                                         |                        
| |                                                    |                        

| | g. | Taxes
on income (tax benefit) included in the statements of operations:
| | -- | -----------------------------------------------------------------------

| |                                               |  |  |  
| | --------------------------------------------- |  |  | -
|
|
|
|
| | Current:                                      |  |  |  
| | Foreign                                       |  |  | $
| |                                               |  | 
| | Deferred:                                     |  | 
| | Domestic                                      |  |  |  
| | Foreign                                       |  |  |  
| |                                               |  | 
| | Taxes in respect of prior years:              |  | 
| | Domestic                                      |  |  |  
| | Foreign                                       |  |  |  
| |                                               |  |  |  
| | Taxes on income (tax benefit) from continuing |  | 
| | operations                                    |  |  |  
| | Tax benefit from discontinued operations      |  |  |  
| |                                               |  |  |  
| |                                               |  | 
| | Total taxes on income (tax benefit)           |  |  | $
| |                                               |  |  |  

F - 38

---

---

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

# NOTE 14:- 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s deferred tax assets
are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                 | December 31,
| | ----------------------------------------------- | ------------
|
|
|
|
| | Operating loss carryforward                     |             
| | Reserves and tax allowances                     |             
| |                                                 |             
| |                                                 |             
| | Total deferred taxes before valuation allowance |             
| | Valuation allowance                             |             
| |                                                 |             
| |                                                 |             
| | Net deferred tax assets                         |             
| |                                                 |             
| |                                                 |             
| | Domestic                                        |             
| | Foreign                                         |             
| |                                                 |             
| |                                                 |             
| |                                                 |             
| |                                                 |             

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

| |          | Year ended December 31,
| | -------- | -----------------------
|
|
|
|
| | Domestic |                        
| | Foreign  |                        
| |          |                        
| |          |                        
| |          |                        
| |          |                        

| | j. | Net
operating carryforward tax losses:
| | -- | --------------------------------------

| | The
Company has estimated total available carryforward tax losses of $ 14,846 to offset
against future taxable income. As of December 31, 2008, the Company recorded a full
valuation allowance on these carryforward tax losses due to the uncertainty of their
future realization.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys subsidiaries have estimated total available carryforward tax losses of $ 9,091,
which may be used to offset against future taxable income, for periods ranging between 13
to 20 years. As of December 31, 2008, the Company recorded a valuation allowance for most
of its subsidiaries carryforward tax losses 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 - 39

---

---

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

# NOTE 14:- TAXES ON
INCOME (Cont.)

| | k. | In
December 2007, the Company finalized with the Israeli Tax Authority the tax
                    assessment with respect to the years 2001-2004.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------

| | l. | The
Company adopted the provisions of FIN 48 on January 1, 2007. The impact on
                    the Companys consolidated financial position and results of
operations as                     a result of the adoption of the provisions of FIN 48
was $ 229, which was                     recognized as an adjustment to retained
earnings.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2008, the Company recorded                     a tax benefit of $59.
| | -----------------------------------------------------------------------

# NOTE 15:- BALANCES AND
TRANSACTIONS WITH RELATED PARTIES

| | a. | Balances
with related parties:
| | -- | ------------------------------

| |                               | December 31,
| | ----------------------------- | ------------
|
|
|
|
| | Balances with related parties |             
| |                               |             

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

| |                          | Year ended December 31,
| | ------------------------ | -----------------------
|
|
|
|
| | Sales to related parties |                        
| |                          |                        

| | c. | Sales
and balances to related parties represent services provided by
                    discontinued operation, see note 18a below.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

| | d. | On December 31, 2007, the retired
Chairman retired from his position. Pursuant to his retirement agreement as amended, the
retired Chairman undertook not to compete with the Company for a period of three years
following his retirement. In consideration, the Company agreed to pay the retired Chairman
a one time payment of $ 360 payable within three months. In addition, the retired Chairman
is entitled to receive certain perquisites from the Company for the rest of his life. The
liability as for December 31, 2008 and the post employment and retirement benefits expense
related to the retirement agreement amounted to $ 603.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---

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

# NOTE 16:- SEGMENT
INFORMATION

| | The
Group adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Group operates in three major reportable segments, which represent
the Groups operating segments as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Perimeter
security systems  The Groups line of perimeter security
                    systems consists of the following: Microprocessor-based central
control units,                     taut wire perimeter intrusion detection systems, INNO
fences, vibration                     detection systems, field disturbance sensors, and
other.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Security
turnkey projects  The Group executes turnkey projects based on
                    the Companys security management system and acts as an
integrator.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Video
monitoring services  The Group supplied video monitoring services
                    through a U.S. subsidiary whose assets and business was sold on
                    December 24, 2007. Therefore, all balances and operations
attributed to the                     video monitoring services segment are classified
and presented as discontinued                     operations, see Note 18a.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---

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

# NOTE 16:- SEGMENT
INFORMATION (Cont.)

| | a. | The
following data present the revenues, expenditures, assets and other
                    operating data of the Groups operating segments:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------

|                        | Year ended December 31,
|----------------------- | -----------------------
|
|
|
|
|Revenues                |                        
|                        |                        
|Depreciation and        |                        
|amortization            |                        
|                        |                        
|Impairment of goodwill  |                        
|and other intangible    |                        
|assets                  |                        
|                        |                        
|                        |                        
|Operating income        |                        
|(loss), before          |                        
|financial expenses and  |                        
|taxes on income         |                        
|                        |                        
|Financial expenses, net |                        
|Taxes on income         |                        
|(tax benefit)           |                        
|Income (loss) from      |                        
|discontinued            |                        
|operations, net         |                        
|                        |                        
|                        |                        
|Net income              |                        
|(loss)                  |                        
|                        |                        

|                        | December 31,
|----------------------- | ------------
|
|
|
|
|Total long-lived assets |             
|                        |             

F - 42

---

---

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

# NOTE 16:- SEGMENT
INFORMATION (Cont.)

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

| |            | Year ended December 31,
| | ---------- | -----------------------
|
|
|
|
| | Customer A |                        
| |            |                        
| |            |                        
| | Customer C |                        
| |            |                        

| | *) | 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,
| | -- |  | -----------------------
|
|
|
|
| | 1. |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| | 2. |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        

F - 43

---

---

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

# NOTE 17:- SELECTED
STATEMENTS OF INCOME DATA

| | a. | Research
          and development expenses, net:
| | -- | -------------------------------------------------

| |                                             | Year ended December 31,
| | ------------------------------------------- | -----------------------
|
|
|
|
| | Expenses                                    |                        
| | Less - investment tax credits and a royalty |                        
| | bearing grant ( $8K in 2005)                |                        
| |                                             |                        
| |                                             |                        
| |                                             |                        
| |                                             |                        

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

| |                                           |  |  |  
| | ----------------------------------------- |  |  | -
|
|
|
|
| | Financial expenses:                       |  |  |  
| | Interest on long-term debt                |  |  | $
| | Interest on short-term bank credit        |  |  |  
| | Forward contracts losses                  |  |  |  
| | Foreign exchange losses                   |  |  |  
| | Marketable securities losses              |  |  |  
| |                                           |  |  |  
| |                                           |  | 
| |                                           |  |  |  
| |                                           |  |  |  
| | Financial income:                         |  | 
| | Interest on short-term and long-term bank |  | 
| | deposits, structured notes and marketable |  | 
| | securities                                |  |  |  
| | Foreign exchange gains                    |  |  |  
| |                                           |  |  |  
| |                                           |  | 
| |                                           |  |  |  
| |                                           |  |  |  
| |                                           |  | 
| |                                           |  |  | $
| |                                           |  |  |  

# NOTE 18:- DISCONTINUED
OPERATIONS

| | a. | General:
| | -- | --------

| | On
July 28, 2005, the Company decided to dispose of its indoor security sensors operations.
| | -------------------------------------------------------------------------------------------

| | On
December 24, 2007, the Company decided to sell its U.S. based video monitoring business
for $ 8,500. The video monitoring business was previously reported as a separate segment
in the Groups financial statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
view of the above, the operating results and cash flows attributed to the indoor security
sensors operations and video monitoring business were presented in the Companys
statements of operations and cash flows as discontinued operations. Accordingly, the
comparative figures were reclassified for all periods presented.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

---

---

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

# NOTE 18:- DISCONTINUED
OPERATIONS (Cont.)

| | b. | The
          following are the results of the discontinued operations for the years ended
          December 31, 2006, 2007 and 2008:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------

| | Indoor
security sensors operations:
| | -----------------------------------

| |                          | Year ended
December 31,
2006
| | ------------------------ | ----------------------------
|
|
|
|
| | Revenues                 |                             
| | Cost of revenues         |                             
| |                          |                             
| |                          |                             
| | Gross loss               |                             
| |                          |                             
| |                          |                             
| | Operating expenses:      |                             
| | Sales and marketing, net |                             
| |                          |                             
| |                          |                             
| | Operating loss           |                             
| | Tax benefit              |                             
| |                          |                             
| |                          |                             
| | Net loss                 |                             
| |                          |                             

| | Video
monitoring:
| | -----------------

| |                                            | Year ended December 31,
| | ------------------------------------------ | -----------------------
|
|
|
|
| | Revenues                                   |                        
| | Cost of revenues                           |                        
| |                                            |                        
| |                                            |                        
| | Gross profit                               |                        
| |                                            |                        
| |                                            |                        
| | Operating expenses:                        |                        
| | Sales and marketing                        |                        
| | General and administrative                 |                        
| |                                            |                        
| |                                            |                        
| | Operating loss                             |                        
| |                                            |                        
| | Capital gain from sale of video monitoring |                        
| | activity                                   |                        
| | Financial income, net                      |                        
| | Tax expense                                |                        
| |                                            |                        
| |                                            |                        
| | Net income (loss)                          |                        
| |                                            |                        

F - 45

---

---

|                                                                    |                                    |       
|------------------------------------------------------------------- | ---------------------------------- | ------
|                                                                    | Salles, Sáinz-Grant Thornton, S.C. | (LOGO)
|Certified
 Public AccountantsMember of Grant Thornton International |                                    |       

Report
of Independent Registered Public Accounting Firm To the Shareholders of Senstar Stellar Latin
America, S. A. de C.V.: We
have audited the accompanying balances sheets of SENSTAR STELLAR LATIN AMERICA,
S.A. DE C.V. (incorporated in Mexico), as of December 31, 2007 and 2006, and
the related statements of operations, changes in shareholders equity, and cash
flows for each of the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on the financial statements based on our audits. We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit 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, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion. In
our opinion, the translated financial statements referred to above present
fairly, in all material respects, the financial position of Senstar Stellar
Latin America, S.A. de C.V. as of December 31, 2007 and 2006, and the related
statements of operations, changes in shareholders equity and cash flows for
each of the years then ended in conformity with the accounting principles
generally accepted in the United States of America. SALLES, SAINZ  GRANT THORNTON, S.C.-s- Hector Bautista CPABy: Hector Bautista CPA Mexico City, Mexico 
     January 31, 2008


F - 46

---

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Report of Independent
Registered Public Accounting Firm To the Shareholders of Senstar Stellar Latin
America, S. A. de C.V.: We
have audited the accompanying balances sheets of SENSTAR STELLAR LATIN AMERICA,
S.A. DE C.V. (incorporated in Mexico), as of December 31, 2008 and 2007, and the
related statements of operations, changes in shareholders equity, and cash
flows for each of the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on the financial statements based on our audits. We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit 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, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our
opinion, the translated financial statements referred to above present fairly,
in all material respects, the financial position of Senstar Stellar Latin
America, S.A. de C.V. as of December 31, 2008 and 2007, and the related
statements of operations, changes in shareholders equity and cash flows for
each of the years then ended in conformity with the accounting principles
generally accepted in the United States of America. SALLES, SAINZ  GRANT THORNTON, S.C.-s- Hector Bautista C.P.A.By: Hector Bautista C.P.A. Mexico City, Mexico 
     March 27, 2009


F - 47

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# SCHEDULE OF VALUATION
AND QUALIFYING ACCOUNTS
(U.S. dollars in
thousands)

| | Balance at end of
period | Translation
adjustments | Provision for
doubtful
accounts | Balance at
beginning
of period | 
| | ------------------------ | ----------------------- | ------------------------------- | ------------------------------ | 
|
|
|
|
| |                          |                         |                                 |                                | 
| |                          |                         | $                               | 1,506                          | 
| |                          |                        
| |                          |                         |                                 |                                | 
| |                          |                         | $                               | 343                            | 
| |                          |                        
| |                          |                         |                                 |                                | 
| |                          |                         | $                               | 384                            | 

86

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# SIGNATURE

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

| |  | MAGAL SECURITY SYSTEMS LTD.By: /s/ Jacob Perry
Jacob PerryChairman of the Board of Directors
| |  | ----------------------------------------------------------------------------------------------------------

Date: July 12, 2009

87

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